NEW JERSEY ALLOCATION LAW: HOW TO
CALCULATE SOLVENT AND INSOLVENT INSURERS’
PRO-RATA SHARES FOR LONG-TAIL CLAIMS
John T. Waldron III and Sara N. Brown
I. Introduction................................................................................
II. Pre-Farmers Mutual: New Jersey Allocation Law Involving
Insolvent Insurers .......................................................................
III. The Farmers Mutual Decision ...................................................
A. Background...........................................................................
B. The Supreme Court’s Decision Addresses Both Who Must
Pay for an Insolvent Insurer’s Share and Whether That
Entity May Recover from the Guaranty Association .........
1. Solvent Insurers, Not the Policyholder, Must Pay for
the Owens-Illinois Shares of Insolvent Insurers ..............
2. The Solvent Insurers That Pay for the Owens-Illinois
Shares of Insolvent Insurers May Not Recover from the
Guaranty Association Until All Applicable Solvent
Insurance Is Exhausted ...................................................
3. The Court Confirms That Its Ruling Applies to Pre2004 Insurance Policies ..................................................
C. Ward Sand and the Application of Farmers Mutual to Pre2004 Insolvencies .................................................................
IV. A Post-Farmers Mutual World: How to Calculate Insurers’
Shares and Apply or Credit Payments Against Limits of
Liability.......................................................................................
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John T. Waldron III is a partner of K&L Gates LLP and is experienced in complex
commercial litigation, including insurance coverage disputes. Sara N. Brown is an associate of K&L Gates LLP and focuses her practice on complex commercial litigation, including insurance coverage disputes. The views expressed in this article are not necessarily those
of K&L Gates LLP or its clients nor does it contain legal advice.
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A. How Are the Pro-Rata Shares to Be Calculated? The ProRata Shares of Solvent and Insolvent Insurers Are to Be
Calculated Consistent with Owens-Illinois and Its Progeny
1. The Owens-Illinois Methodology ....................................
2. Insolvent Policies Must Be Included in the Calculation
of Pro-Rata Shares ..........................................................
B. Who Pays? In the Absence of “Drop Down” Coverage, the
Solvent Insurers That Issued Coverage Triggered by a
Claim Must Pay for an Insolvent Insurer’s Pro-Rata Share
C. How Are Payments Applied Against the Limits of Liability
of the Triggered Solvent and Insolvent Policies? Amounts
That Solvent Insurers Pay on Account of Their
“Traditional” Share Serve to Erode Their Limits, While
the Amounts They Pay When “Standing in the Shoes of ”
an Insolvent Insurer Do Not and Instead Are “Credited”
Against the Limits of the Insolvent Policy for Purposes of
Accessing Excess Coverage ..................................................
V. This Article’s Approach Is Supported by New Jersey Public
Policy, the Principles Underlying New Jersey Insurance Law,
and the Purposes of the PLIGA Act.........................................
VI. Conclusion..................................................................................
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abstract
In a decision of significant importance in insurance coverage disputes, the
Supreme Court of New Jersey clarified how the costs associated with
long-tail bodily injury and property damage claims are to be allocated
among the relevant insurers on the risk when one or more of those insurers are insolvent. The court implicated the New Jersey Property-Liability
Insurance Guaranty Association Act, but its decision raised new issues for
the mechanics of an allocation involving insolvent insurers. First, the
court determined that the solvent insurers involved in such a claim, and
not the policyholder, must pay for the insolvent insurers’ shares of the
claim. Second, the court held that the Guaranty Association may be obligated to reimburse only amounts attributable to an insolvent insurer only
after the solvent insurance has been exhausted. Faced with a simple coverage map involving only two insurers, the court was not presented with,
and did not decide, how these two principles would be applied in more
complex scenarios involving both primary and excess policies. This article
explores the ramifications of the court’s important decision and proposes
a methodology to calculate New Jersey’s unique allocation approach to
such claims in a way that reconciles the court’s analysis with its earlier decisions on allocation issues.
New Jersey’s Allocation Law, Insolvent Insurers, and Long-Tail Claims
749
i. introduction
Since the 1970s, disputes between corporate policyholders and their liability and property insurers over insurance coverage for progressive,
long-tail bodily injury and property damage losses and liabilities have become commonplace.1 Because such long-tail losses and liabilities typically
implicate several different insurers and policies spanning multiple years,
these disputes often turn on an issue known as “allocation” or “scope of
coverage,” which seeks to determine the extent to which each implicated
insurer is responsible for the loss or liability.
To resolve this allocation dispute, courts across the country have
adopted varying methods. For instance, certain courts have adopted the
so-called all-sums approach, under which a policyholder is allowed “to
seek full coverage for its claims from any single policy, up to that policy’s
coverage limits, out of the group of policies that has been triggered.”2
Other courts have embraced the so-called pro-rata time-on-the-risk
method, under which “each insurer pays only a portion of a claim based
on the duration of the occurrence during its policy period in relation to
the entire duration of the occurrence. It divides a loss ‘horizontally’
among all triggered policy periods, with each insurance company paying
only a share of the policyholder’s total damages.”3
By comparison, New Jersey courts have adopted a unique “pro rata
time on the risk and weighted by limits” approach.4 Under this approach,
the loss in question is allocated among the implicated insurers, with each
insurer responsible for a “pro-rata-weighted-by-limits” share that is calculated based on not only its time on the risk but also the amount of available limits triggered by the loss.
Under New Jersey’s approach, questions have arisen as to how responsibilities for a loss or liability are to be calculated when an insurer that issued one or more of the policies triggered by a claim becomes insolvent.
Insurers routinely contend that the policyholder is responsible for an insolvent insurer’s share of a long-tail loss. However, this contention has
been undermined by the decision of the New Jersey Supreme Court in
Farmers Mutual Fire Insurance Co. of Salem v. New Jersey Property-Liability
1. In long-tail injuries, such as those from asbestos exposure, the manifestation of the injury may occur years or decades after initial exposure. See generally Owens-Illinois, Inc. v.
United Ins. Co., 650 A.2d 974, 980–85 (N.J. 1994).
2. Goodyear Tire & Rubber Co. v. Aetna Cas. & Sur. Co., 769 N.E.2d 835, 840 (Ohio
2002).
3. Id. (internal quotations omitted).
4. Owens-Illinois, 650 A.2d at 995 (“Because multiple policies of insurance are triggered
under the continuous-trigger theory, it becomes necessary to determine the extent to
which each triggered policy shall provide indemnity. . . . A fair method of allocation appears
to be one that is related to both the time on the risk and the degree of risk assumed.”).
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Insurance Guaranty Association,5 which interpreted the New Jersey PropertyLiability Insurance Guaranty Association Act (the PLIGA Act)6 and the
New Jersey Surplus Lines Insurance Guaranty Fund Act (the Guaranty
Fund Act),7 including amendments enacted in 2004.
In Farmers Mutual, the New Jersey Supreme Court addressed two distinct issues that arise in the context of long-tail claims that trigger policies
of both solvent and insolvent insurers for which the Guaranty Association
(or Guaranty Fund) is obligated to handle claims against at least one of
the insolvent insurers.8 First, the court clarified that the PLIGA Act requires that the solvent insurers, but not the policyholder, must pay for
the shares of the claim that would have been allocable to an insolvent insurer but for its insolvency. The court’s ruling in this regard was based on,
inter alia, the very purposes of the PLIGA Act—to minimize the losses
5. 74 A.3d 860 (N.J. 2013).
6. N.J. STAT. ANN. §§ 17:30A-1 to -20.
To mitigate the financial distress to insureds and claimants caused by an insurance company’s insolvency, the [New Jersey] Legislature passed the [PLIGA Act].
The PLIGA Act created the Guaranty Association—a private, nonprofit, unincorporated association whose members consist of insurance companies licensed to issue certain
types of insurance policies in New Jersey, including property insurance. The Guaranty Association is empowered to assess members in amounts necessary to pay the covered claims
of an insolvent insurer. The assessments are recouped by insurance carriers, which pass
them on to insureds as a policy premium surcharge.
The Guaranty Association is obligated to stand in the place of an insolvent insurer and
to pay certain claims up to the limit of the policyholder’s contract, subject to a maximum
liability of $300,000.
Farmers Mut., 74 A.3d at 870–71 (internal citations and quotations omitted). “The [PLIGA]
Act applies to all kinds of direct insurance except for specifically enumerated types [listed in
N.J. STAT. ANN. § 17:30A-2(b)].” R.R. Roofing & Bldg. Supply Co. v. Fin. Fire & Cas. Co.,
427 A.2d 66, 69 (N.J. 1981). The specifically excluded types of direct insurance are “life insurance, accident and health insurance, workers’ compensation insurance, except as provided
by P.L.2009, c. 327 (C.34:15-105.1 et al.), title insurance, annuities, surety bonds, credit insurance, mortgage guaranty insurance, municipal bond coverage, fidelity insurance, investment return assurance, ocean marine insurance and pet health insurance.” N.J. STAT.
ANN. § 17:30A-2(b).
7. N.J. STAT. ANN. §§ 17:22-6.70 to -6.83. Like the PLIGA Act, the Guaranty Fund Act
provides statutory benefits to insureds under certain circumstances involving the insolvency
of one of its surplus lines insurers. N.J. STAT. ANN. § 17:22-6.74a(1); see Farmers Mut., 74
A.3d at 869 n.4. Because, for the issues addressed by this article, both Acts operate identically, this article will use the term “Guaranty Association” to refer to both the Guaranty Association and the Guaranty Fund.
8. Notably, the Farmers Mutual decision does not appear to address an allocation involving insolvent insurers for which the Guaranty Association does not have an obligation.
Therefore, all references to “insolvent insurers” in the remainder of this article are limited
only to those insolvent insurers for which the Guaranty Association is implicated. Having
said that, given the public policies and other reasons justifying the court’s ruling that the solvent insurers, not the policyholder, must pay for the shares allocable to insolvent insurers (as
discussed in detail below), it would be sensible for the allocation methodology to be the same
for all insolvent insurers, whether such insurers did or did not implicate the Guaranty
Association.
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suffered by policyholders as a result of insurer insolvency. Second, on the
distinct question of when the Guaranty Association can be called upon to
reimburse an entity for amounts that it paid on behalf of an insolvent insurer, the court held that the Guaranty Association is a “payor of last resort” and hence may not be obligated to pay until the relevant solvent insurance is exhausted.
This article addresses how to determine, in light of Farmers Mutual,
the responsibility for losses when insolvent insurers are implicated by a
long-tail claim. In particular, this article focuses on three key issues that
have either been clarified by the New Jersey Supreme Court in Farmers
Mutual or that are a logical extension of the court’s reasoning: (1) how
pro-rata shares are calculated under New Jersey allocation law when
one of the policies triggered by the claim is insolvent; (2) who pays for
an insolvent insurer’s share of a long-tail loss (the solvent insurer whose
policy sits immediately above the insolvent insurer’s policy, the solvent insurers that issued policies triggered by the loss including in years other
than the year of the insolvent policy, the policyholder, or the Guaranty
Association); and (3) how these payments count (if at all) against the limits
of liability of the triggered policies, both those issued by the insolvent insurer and those by the solvent insurers involved.
As this article explains, the New Jersey Supreme Court has made clear
that, when a long-tail claim triggers both solvent and insolvent policies,
the solvent policies provide functionally two types of coverage:
• First, consistent with Owens-Illinois and its progeny, the solvent policies are
to be allocated their typical pro-rata-weighted-by-limits share that is calculated as if all of the triggered policies were issued by solvent insurers (referred to in this article as their “traditional” share). A solvent insurer’s payment of its traditional share would, not surprisingly, serve to erode its
policy’s limits of liability, consistent with such policy’s terms.
• Second, and separate and apart from its “traditional” share, a solvent insurer, functionally “standing in the shoes” of the insolvent insurer, is to
be allocated a second share that represents its proportionate liability for
the insolvent insurer’s pro-rata-weighted-by-limits share (referred to in
this article as the “second share” or “standing in the shoes” share). The calculation of these shares is to be done consistently with the traditional prorata-weighted-by-limits methodology set forth by the New Jersey Supreme
Court in Owens-Illinois and its progeny.
• Further, except in instances in which the policy language permits such an
interpretation, the allocation must be calculated in a manner that is compatible with the New Jersey Supreme Court’s prior rulings on whether an
excess policy sitting immediately above an insolvent policy may “drop
down” to replace the insolvent policy’s coverage.
• Finally, while the “traditional” share that a solvent insurer pays on account
of its own policy does impair the solvent policy’s limits of liability (to the
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extent that its terms provide), the “standing in the shoes” share that a solvent insurer pays on account of an insolvent policy does not impair the solvent policy’s limits. Instead, this “second share” should be “credited”
against the limits of liability of the insolvent policy (to the extent that its
terms provide), although such credit does not actually impair the insolvent’s limits and instead is done for the purpose of allowing the excess coverage sitting above such insolvent policy to be accessed, to avoid permitting such excess insurers from arguing that the underlying insolvent
policy can never be exhausted and therefore that their excess coverage
never attaches.
As discussed in detail below, this article’s approach is supported not
only by the rulings in Farmers Mutual, but also by Owens-Illinois and its
progeny, New Jersey public policy, the purposes of the PLIGA Act,
and equitable and other considerations.
ii. pre-farmers mutual: new jersey allocation law
involving insolvent insurers
Prior to Farmers Mutual, solvent carriers strenuously asserted that they
did not bear the risk of insurer insolvency. Instead, pointing to dicta by
the New Jersey Supreme Court in Spaulding Composites9 and Benjamin
Moore,10 insurers argued that insolvent policies should be allocated a
pro-rata-weighted-by-limits share the same as if they were solvent, and
that the policyholder must bear responsibility for such a share (or seek
to recover from the insolvent insurer’s estate or any relevant guaranty association). However, because the court in Spaulding Composites and Benjamin Moore was not required to determine who was responsible for an insolvent insurer’s share, the court’s statements in these two cases were
mere dicta and hence did not resolve the question of who must bear responsibility for insolvent shares.11
Relatedly, in Sayre v. Insurance Co. of North America, the Appellate Division addressed the issue of allocating liability when an insurer becomes
9. Spaulding Composites Co. v. Aetna Cas. & Sur. Co., 819 A.2d 410, 417 (N.J. 2003)
(“[T]he insured is required to pay its ‘aliquot’ share of both defense and indemnification on
account of years in which it was uninsured, self-insured, or its coverage was exhausted or
bankrupt.”).
10. Benjamin Moore & Co. v. Aetna Cas. & Sur. Co., 843 A.2d 1094, 1103 (N.J. 2004)
(“Policyholders who chose to ‘go bare’ or underinsure must sustain the burden of those
choices. Likewise, policyholders are required to underwrite the risk of insurer insolvency
or bankruptcy.”).
11. As discussed below, the Farmers Mutual court clarified that solvent insurers, not the
policyholder, are responsible for the pro-rata-weighted-by-limits share that would have
been allocable to an insolvent insurer backed by the Guaranty Association under OwensIllinois had it been solvent. The Farmers Mutual court distinguished the prior statements
in Spaulding Composites and Benjamin Moore, as those cases did not involve insolvent insurers
or the PLIGA Act. See infra Part III.
New Jersey’s Allocation Law, Insolvent Insurers, and Long-Tail Claims
753
insolvent in a progressive environmental injury case involving the Guaranty Fund Act.12 The court determined that “[n]othing in Owens-Illinois
suggests that it would be fair or proper to burden the solvent carriers”
with liability for years during which they were not on the risk13 and
held that “the Fund [was] required to pay the share which would have
been allocated to the [insolvent carrier’s] policy, not exceeding the statutory $300,000 limit.”14
In addition, in Werner Industries, Inc. v. First State Insurance Co., the
New Jersey Supreme Court addressed the issue of whether a solvent excess insurer could be required to “drop down” and provide coverage because the primary policy immediately underlying its excess policy was issued by an insolvent insurer.15 The court held that the excess insurer did
not have to “drop down” to cover the insolvent primary insurer’s share
because “the language of the [excess] policy clearly did not provide for
any ‘dropping down’ . . . for losses not recoverable by reason of the insolvency of the primary insurer” and “[a]bsent evidence that some other action by [the excess insurer] created a different understanding by the insured, the unambiguous language of the contract must be enforced.”16
In sum, prior to Farmers Mutual, the New Jersey Supreme Court had
not clarified how the PLIGA Act interacted with the Owens-Illinois allocation methodology and the decisions in Sayre and Werner.
iii. the farmers mutual decision
A. Background
Farmers Mutual involved two consolidated cases pertaining to the remediation of two contaminated properties, one owned by Edward and Carolyn
O’Brien and the other by Ramnath and Ashmin Sookoo. The O’Brien
property was insured for property damage by Newark Insurance Co.
from August 29, 1999, to August 29, 2002, up to $300,000 per year and
by Farmers Mutual Fire Insurance Co. of Salem from August 29, 2002,
to August 29, 2003, up to $500,000. The Sookoo property was insured
12. Sayre v. Ins. Co. of N. Am., 701 A.2d 1311 (N.J. Super. Ct. App. Div. 1997), superseded
by statute as recognized in Farmers Mut., 74 A.3d at 872.
13. Sayre, 701 A.2d at 1314.
14. Id. at 1313–14 (citing N.J. STAT. ANN. § 17:22-6.74a(1)). Significantly, Sayre was decided before the legislature added an amendment to the PLIGA Act (and the Guaranty Fund
Act) in 2004 that, as discussed below, superseded Sayre according to the New Jersey Supreme
Court in Farmers Mutual. See Part III infra.
15. 548 A.2d 188 (N.J. 1988) (per curiam). The policyholder argued that its excess insurer
was obligated to provide coverage between what the Guaranty Fund should pay ($300,000)
and what it would have received under the primary policy if the primary insurer had remained solvent. Id. at 189–90.
16. Id. at 192.
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for property damage by Newark from December 13, 1998, to December 13, 2002, up to $300,000 per year and by Farmers Mutual from
December 13, 2002, to December 13, 2003, up to $500,000.17
In 2003, oil and groundwater contamination was discovered on both
properties. The contamination indisputably began during periods that
Newark’s insurance covered. Despite being less than seven months on
the O’Brien risk and eight months on the Sookoo risk, Farmers Mutual
paid all of the remediation costs, which totaled $112,165.13 and
$25,958.39, respectively.18
In 2007, Newark was declared insolvent and the Guaranty Association
took over administrating Newark’s claims pursuant to its obligations
under the PLIGA Act. Farmers Mutual subsequently sued the Guaranty
Association for reimbursement of money spent to remediate the properties, arguing that, pursuant to Owens-Illinois, the Guaranty Association
was responsible for Newark’s pro-rata-weighted-by-limits share of the remediation costs. The Guaranty Association refused, claiming that, pursuant to the PLIGA Act, the solvent policies had to be fully exhausted before statutory benefits could be accessed.19
The trial court agreed with Farmers Mutual and held that the Guaranty
Association was subject to the Owens-Illinois methodology. “The court rejected the Guaranty Association’s exhaustion argument and found that,
under the Spill Compensation and Control Act . . . Farmers Mutual had
a right to contribution from the Guaranty Association for the remediation
costs.”20 On appeal, the Appellate Division reversed the trial court’s decision, holding that the 2004 amendment superseded Sayre in continuous
trigger cases involving progressive injury or property damage, such that
the policy limits of solvent insurers must be exhausted before the Guaranty
Association’s contribution requirements could be triggered.21
B. The Supreme Court’s Decision Addresses Both Who Must Pay for an
Insolvent Insurer’s Share and Whether That Entity May Recover from
the Guaranty Association
As noted in Farmers Mutual, the New Jersey Supreme Court had not previously decided how the Owens-Illinois allocation approach works in the
context of insolvent insurers: “Until today, we have not had occasion to
speak to the intersection of the PLIGA Act and the allocation scheme
in long-tail environmental contamination cases.”22 In its decision, the Su17.
18.
19.
20.
21.
22.
Farmers Mut., 74 A.3d at 862–64.
Id. at 863–64.
Id. at 864.
Id.
Id. at 863–65, 870.
Id. at 874.
New Jersey’s Allocation Law, Insolvent Insurers, and Long-Tail Claims
755
preme Court resolved two distinct issues: (1) who must pay for the insolvent insurer’s share—the policyholder or the solvent insurers triggered by
the claim in question—and (2) when may such paying entity recover from
the Guaranty Association.
1. Solvent Insurers, Not the Policyholder, Must Pay for
the Owens-Illinois Shares of Insolvent Insurers
Amicus curiae Zurich American Insurance Co. argued that the policyholder
should pay for the insolvent insurer’s pro-rata shares under the OwensIllinois methodology, not the solvent insurer whose policies were triggered
by a claim. The court explicitly rejected this position, stating that such an
interpretation “would turn the PLIGA Act on its head.”23 The court determined that the Act “created the Guaranty Association as a means of
providing benefits to insureds that, through no fault of their own, have
lost coverage due to the insolvency of their carriers.”24 Moreover, the
Act’s aim to “minimize financial loss to claimants or policyholders because of the insolvency of an insurer . . . would be defeated by making
the insured bear the loss for the carrier’s insolvency before the insured received any statutory benefits from the Guaranty Association.”25 By explicitly rejecting Zurich’s position, the court’s holding is clear that solvent insurers triggered by a claim—not the policyholder—must pay insolvent
insurers’ shares.26
2. The Solvent Insurers That Pay for the Owens-Illinois Shares of
Insolvent Insurers May Not Recover from the Guaranty Association
Until All Applicable Solvent Insurance Is Exhausted
Having determined that solvent insurers, not the policyholder, must pay
for the shares of insolvent insurers, the court then addressed the second,
distinct question of whether such solvent insurers could then seek reimbursement of such amounts from the Guaranty Association. On that second issue, the New Jersey Supreme Court affirmed the Appellate Division’s determination, holding that, in long-tail, continuous-trigger cases
where an insolvent carrier is on the risk along with solvent carriers, the
policy limits of the solvent carriers must first be exhausted before statutory benefits may be obtained from the Guaranty Association.27 In so
23. Id. at 873.
24. Id. at 872.
25. Id. at 873.
26. Id. at 873, 875 (stressing that “[t]he PLIGA Act is intended ‘to minimize financial loss
to claimants or policyholders because of the insolvency of a property or casualty insurer.’ ”)
(quoting Senate Commerce Comm., Statement to Senate Comm. Substitute for Senate
Nos. 702 & 1580 (May 17, 2004)).
27. Id. at 863, 875.
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holding, the court looked to the PLIGA Act’s plain language and purposes, Owens-Illinois, and its progeny.28
The court noted that the PLIGA Act had always required that, “when a
claim arises under policies issued by both a solvent and insolvent insurer,
the claimant must first exhaust the policy of the solvent insurer.”29 Prior
to 2004, the term “exhaust” had not been defined in the Act. In 2004, an
amendment added a definition for “exhaust” and clarified that, in continuous injury or damage cases, such exhaustion includes applicable coverages in effect in other years implicated by the injury or damage.30 Specifically, “exhaust” was defined as follows:
“Exhaust” means with respect to other insurance, the application of a credit
for the maximum limit under the policy, except that in any case in which continuous indivisible injury or property damage occurs over a period of years as a result
of exposure to injurious conditions, exhaustion shall be deemed to have occurred only
after a credit for the maximum limits under all other coverages, primary and excess, if applicable, issued in all other years has been applied. . . .31
Because the legislature “defin[ed] the word ‘exhaust’ in continuous-trigger
cases involving progressive injury and property damage,” the court held
that solvent coverage triggered by a claim, including in policy periods
other than the insolvent insurer’s, must be exhausted before the Guaranty
Association’s benefits may be accessed.32 Based on such statutory language, the court determined that it was reasonable to conclude that the
legislature intended to reverse Sayre.33
The court concluded that the PLIGA Act “clearly intended to make
the Guaranty Association the insurer of last resort in triggered years in
long-tail environmental contamination cases” and “the Guaranty Association is not responsible for reimbursement payments unless the solvent
28. Id. at 867–74.
29. Id. at 871.
30. Id. at 871–72.
31. N.J. STAT. ANN. § 17:30A-5 (emphasis added); N.J. STAT. ANN. § 17:22-6.72 (same).
The Farmers Mutual court determined that “[t]here can be no doubt that these statutes,
which repeat almost verbatim the language of Owens-Illinois, . . . are referring to the continuous trigger doctrine.” Farmers Mut., 74 A.3d at 872 (citing Owens-Illinois, Inc. v. United
Ins. Co., 650 A.2d 974, 995 (N.J. 1994) (“[W]hen progressive indivisible injury or damage
results from exposure to injurious conditions for which civil liability may be imposed, courts
may reasonably treat the progressive injury or damage as an occurrence within each of the
years of a CGL policy.”)).
32. Farmers Mut., 74 A.3d at 871–72.
33. Id. (“If the Legislature were content with the Sayre decision—a continuous-trigger
case—in which the Guaranty Fund was required to step into the shoes of the insolvent carrier
for proration purposes, there would have been little point to adding the 2004 amendments,
N.J. STAT. ANN. § 17:30A-5 and N.J. STAT. ANN. § 17:22-6.72, defining exhaustion in cases
of ‘continuous indivisible injury or property damage occur[ring] over a period of years as a
result of exposure to injurious conditions.’ ”).
New Jersey’s Allocation Law, Insolvent Insurers, and Long-Tail Claims
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carrier’s policy limits are first exhausted.”34 “Thus, when one of several
insurance carriers on the risk is insolvent in a continuous-trigger case,
the limits of the policies issued by solvent insurers ‘in all other years’
must first be exhausted before the Guaranty Association is obligated to
pay statutory benefits.”35
3. The Court Confirms That Its Ruling Applies to Pre-2004
Insurance Policies
Additionally, the court rejected Farmers Mutual’s argument that the 2004
amendment impaired its preexisting contractual rights in violation of federal and state constitutions. Under New Jersey law, “[l]egislation unconstitutionally impairs a contract when it (1) substantially impair[s] a
contractual relationship, (2) lack[s] a significant and legitimate public purpose, and (3) is based upon unreasonable conditions and . . . unrelated to
appropriate governmental objectives.”36 As to the first prong, the court
reasoned that, in a highly regulated industry like insurance, insurers
have “no ‘contractual expectation’ that a naturally fluid regulatory
scheme, ‘subject to change at any time,’ will remain in an unalterably
fixed state.”37 The court also noted that Farmers Mutual was not “required to pay beyond the maximum policy limits that it insured.”38 As
to the second and third prongs, the court determined that Farmers Mutual’s argument fell short because the “PLIGA Act—inclusive of the
2004 amendment—is motivated by ‘significant and legitimate’ public policy goals and imposes ‘reasonable conditions’ related to ‘appropriate governmental objectives.’ ”39
Thus, in so ruling, the court made clear that its holdings applied to insurance policies that were in effect (and injury or damage that took place)
prior to 2004.
34. Id. at 863, 873–75 (holding that the insureds must “exhaust the limits of the policies
issued by solvent insurers before applying to the Guaranty Association for statutory benefits”); see also id. at 871 (stating that the language of N.J. STAT. ANN. § 17:30A-12b clearly
demonstrated that “[t]he conservation of the Guaranty Association’s resources is an objective
of the PLIGA Act”).
35. Id. at 872 (quoting N.J. STAT. ANN. § 17:30A-5). “In other words, if there are no solvent carriers on the risk ‘in all other years,’ N.J.S.A. 17:30A-5 is not ‘applicable’ because then
there are no ‘other coverages, primary and excess’ to be exhausted.” Id.
36. Id. at 874 (internal quotations omitted; first set of brackets added; ellipsis in original).
37. Id. at 874–75 (reasoning that Farmers Mutual’s vision on how Owens-Illinois would
work “did not vest it with a right to the outcome it wanted” because “courts routinely consider whether the parties should have anticipated changes in the governing law in a regulated
industry” and insurers “have been on notice that in long-tail, continuous-trigger cases involving indivisible injury Owens-Illinois would not be the last word” on allocation) (internal
quotations omitted).
38. Id. at 875.
39. Id. (brackets omitted) (quoting State Farm Mut. Auto. Ins. Co. v. State, 590 A.2d 191,
208 (N.J. 1991)).
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C. Ward Sand and the Application of Farmers Mutual to Pre-2004
Insolvencies
Since the Farmers Mutual decision, one court has tried to tackle whether
that decision applies to policies issued by insurers that became insolvent
prior to the 2004 amendments to the PLIGA Act and Guaranty Fund
Act. Specifically, in an unreported decision that is currently on appeal,
the trial court in Ward Sand & Materials Co. v. Transamerica Insurance
Co.40 held that Farmers Mutual applies only to insolvencies that took
place after the 2004 amendments became effective and hence that it did
not clarify the law with respect to policies issued by insurers that happened to become insolvent earlier.
While a full discussion of the merits of the Ward Sand decision is outside the scope of this article, the rationale underlying that decision, assuming it even survives appeal, is debatable. For instance, even assuming
arguendo that the trial court’s conclusion that the 2004 amendments only
have prospective effect is correct,41 such a holding would relate at most
only to the second question addressed above—specifically, that the Guaranty Association may not be liable until after all of the relevant solvent insurance has been exhausted. The court’s decision on the first question addressed above, i.e., that solvent insurers, not the policyholder, must pay in
the first place for the Owens-Illinois shares of insolvent insurers, did not
turn on the 2004 amendments to the PLIGA Act. Rather, the court expressly rejected Zurich’s position that the insured must pay for such
shares based on the overall purposes of the PLIGA Act, such as “ ‘to minimize financial loss to claimants or policyholders because of the insolvency of an insurer,’ ”42 purposes that have been in effect since the
PLIGA Act was first enacted. Thus, to the extent that Ward Sand suggests
that the decision on this first issue in Farmers Mutual—that solvent insurers, not policyholders, must pay for the shares of insolvent insurers—is
limited to insolvencies that took place after the effective date of the
40. No. CAM-L-4130-09, 2013 N.J. Super. LEXIS 197 (Law Div. Nov. 13, 2013).
41. The trial court in Ward Sand relied on a footnote in Thomsen v. Mercer-Charles, 187
N.J. 197, 205 n.2 (2006), in which the New Jersey Supreme Court noted that the 2004
amendments applied prospectively only. Whether the 2004 amendments are to be applied
prospectively only or retroactively is outside the scope of this article, but it bears noting
that Thomsen, which did not involve either policies issued to the same first-named insured
or continuous injury or damage claims, simply dealt with the setoff provision under the
PLIGA Act. As such, at a minimum, Thomsen clearly has no bearing on the “first question”
addressed in Farmers Mutual in which the New Jersey Supreme Court plainly rejected Zurich’s position that the policyholder was responsible for amounts allocable to insolvent insurers under the Owens-Illinois allocation approach.
42. Farmers Mut., 74 A.3d at 873 (quoting N.J. STAT. ANN. § 17:30A-2).
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2004 amendments, Ward Sand is simply incorrect and conflates the two
separate issues addressed in Farmers Mutual.43
In fact, it would make little sense for the Owens-Illinois allocation approach (as between insureds and solvent insurers) to vary based on
whether an insolvent insurer’s insolvency happened to take place before
or after the effective date of the 2004 amendments. In addition to being
inequitable, such a result would likely be unworkable in practice, leading
to even more litigation over how to allocate claims (and increased litigation is the opposite of what the New Jersey Supreme Court intended in
Owens-Illinois).
There is nothing in Farmers Mutual that suggests that the New Jersey
Supreme Court envisioned that the allocation question as between insureds and solvent insurers would turn on whether the insolvency in question happened before or after 2004. To the contrary, the court made clear
that, in addition to the overall goals of the PLIGA Act noted above, the
purpose of the Owens-Illinois methodology itself is “to make insurance coverage available, to the maximum extent possible, to redress such matters as
toxic contamination of property.”44 Indeed, in rejecting Farmers Mutual’s
position, the court indicated that the 2004 amendment was simply a clarification of the PLIGA Act’s earlier exhaustion provision.45 Thus, any suggestion by the Ward Sand decision that the 2004 clarification was instead a
fundamental change that causes an entirely different allocation approach to
be applied to insolvencies taking place prior to 2004 from those that take
place after is contrary to the reasoning of Farmers Mutual.
Further, the fact that the Farmers Mutual court explicitly ruled that its
approach applied to policies that were in effect, and property damage that
took place, prior to the 2004 amendments indicates that the court did not
intend for its approach to be limited to insolvencies that happened to take
place after 2004.
In sum, the approach advocated in this article, which we now turn to in
detail, is consistent with a proper reading of both Farmers Mutual and
Ward Sand. Any reading of Ward Sand that requires insureds, rather
43. In its decision, the Ward Sand trial court stated, without support: “It would be unfair
to charge solvent insurers with a risk they did not assume—the risk of another insurer’s insolvency.” 2013 N.J. Super. LEXIS 197, at *17. But it is no more fair to charge a policyholder with that risk. Indeed, as discussed further below, solvent insurers often charge a “premium surcharge” to policyholders to account for payments that such insurers may need to
make relating to guaranty associations. See Parts IV.C and V infra; see also note 6 supra
and note 54 infra; Farmers Mut., 74 A.3d at 871 (referencing such surcharges). Further, insurers by virtue of their participation in the insurance industry are in a better position than a
policyholder to evaluate the likelihood that another insurer will become insolvent and to
spread that risk economically and efficiently. As such, the above statement in Ward Sand,
which echoed a similar unsupported statement in Sayre, is without merit.
44. Farmers Mut., 74 A.3d at 863 (emphasis added).
45. Id. at 874.
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than solvent insurers, to pay for the Owens-Illinois shares of insolvent insurers for continuous injury or damage claims would be contrary to the
reasoning of Farmers Mutual and hence should be rejected.
iv. a post-farmers mutual world: how to calculate
insurers’ shares and apply or credit payments
against limits of liability
Based on the decision in Farmers Mutual and an extension of its logic, this
article proposes that the following approach be utilized in allocating the
costs associated with long-tail bodily injury and property damage claims
when at least one of the insurers on the risk is insolvent: (1) the OwensIllinois pro-rata-weighted-by-limits methodology is used and both solvent
and insolvent policies triggered by a claim are included in calculating the
pro-rata shares; (2) the solvent insurers must pay for not only their own
traditional pro-rata shares but also the pro-rata shares of the insolvent insurers governed by the PLIGA Act, and hence these solvent insurers are
functionally providing two types of coverage; and (3) the amounts paid on
account of the solvent insurer’s traditional pro-rata share erode the limits
of liability of the solvent policy (as appropriate under its terms), while the
amounts paid on account of the insolvent insurer’s pro-rata share are
“credited” (as appropriate) against the limits of the insolvent policy (solely
for purposes of accessing the excess coverage sitting above such insolvent
policy), not the solvent policy’s limits (even though the solvent insurer is
paying such amounts).
A. How Are the Pro-Rata Shares to Be Calculated? The Pro-Rata Shares of
Solvent and Insolvent Insurers Are to Be Calculated Consistent with
Owens-Illinois and Its Progeny
1. The Owens-Illinois Methodology
The calculation of pro-rata shares under New Jersey’s allocation approach
is based on the policy periods triggered by the claim and the available limits obtained by the insured during such policy periods.
As an example, Figure 1 depicts a typical Owens-Illinois allocation in
which all of the policies were issued by solvent insurers and a $1 million
claim triggered all four years.
Consistent with the Owens-Illinois methodology, the Year 1 insurer is
liable for 1/10th of the risk, the Year 2 insurers are liable for 2/10th of
the risk, the Year 3 insurers are liable for 3/10th of the risk, and the
Year 4 insurers are liable for 4/10th of the risk. Thus, the allocable
amount of liability is $100,000 to Year 1, $200,000 to Year 2, $300,000
to Year 3, and $400,000 to Year 4.
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Figure 1: One Million Dollar Claim and No Insolvent Insurers
Because it is assumed here that none of the insurers is insolvent and
none of the policies has any prior impairment, all of these amounts are
paid by the primary insurers, as depicted in Figure 1. None of the excess
policies is implicated because none of the primary policies has been
exhausted.
2. Insolvent Policies Must Be Included in the Calculation of
Pro-Rata Shares
The above Owens-Illinois example includes policies in the calculation regardless of whether they were issued by solvent or insolvent insurers.
Farmers Mutual did not change this approach.
If policies issued by insolvent insurers were not included in the OwensIllinois calculation, it would lead to unreasonable results.
First, if no amounts were attributable to the insolvent policies, it would
arguably hinder or even preclude the insured from being able to access the
excess policies sitting above the insolvent policies, assuming such excess
policies did not “drop down” to provide coverage.
Second, if insolvent policies were excluded from the calculation, assuming different relevant insurers became insolvent at different times,
the pro-rata percentages would necessarily change over time. Such a complicated and confusing result may also undermine settlement efforts, as an
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Figure 2
insured may need to wait to see if a financially distressed insurer was
going to become insolvent before the insured settled with other insurers.
For example, assume, as depicted in Figure 2, that the primary policy in
Year 2 and the second-layer excess policy in Year 4 were issued by an insolvent insurer and that, based on their policy language, none of the solvent policies “drop down” to provide coverage in place of the insolvent
policy. As with Figure 1, assume that a $1 million claim triggers all
four years and that there is no preexisting impairment of any policies.
If insolvent policies are not accounted for in the calculation of pro-rata
shares, then, instead of allocating 10 percent, 20 percent, 30 percent, and
40 percent to the respective four years, the calculation would change, although the result would not be clear and could lead to conflicting and dubious results. One option would be to ignore Year 2 entirely and allocate
12.5 percent to Year 1, 0 percent to Year 2, 37.5 percent to Year 3, and
50 percent to Year 4. Another option would be to also exclude Year 4’s
insolvent policy (but not all of Year 4) from the calculation, such that
the allocation would be 14 percent (1/7th) to Year 1, 0 percent to
Year 2, 43 percent (3/7th) to Year 3, and 43 percent (3/7th) to Year 4. Numerous other complicated and questionable possibilities exist. In addition,
even if it were clear what the initial pro-rata percentages should be, those
shares presumably may change once the attachment point of Year 4’s insolvent policy were reached.
Perhaps more significantly, if insolvent policies are not included in the
calculation in some fashion, it is unclear how the policyholder may ever
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763
access the solvent coverage that is excess of the insolvent policies. If no
dollars are allocated to the Year 2 primary policy (or its limits are not otherwise “credited” for purposes of accessing the excess coverage above it),
its limits will remain fully intact. If the excess insurer above it is not required to “drop down,” it will contend that its coverage may not be accessed until the full underlying limits have been exhausted or otherwise
accounted for.
This difficulty increases as additional insolvent policies are reached.
For instance, assume that additional claims are asserted against the insurance program depicted in Figure 2 such that the primary and first-layer
excess policies of Year 4 become exhausted. If the allocation methodology
does not permit insolvent policies to be included in the calculation, then
again, as with Year 2, (1) the pro-rata percentages of Years 1 and 3 presumably are increased to take into account the elimination of Year 4
from the calculation and (2) the policyholder may be precluded from accessing the solvent third-layer policy in Year 4 (in the absence of “drop
down”). Given that the historical insurance programs of corporations
are often littered with a number of insolvent insurers (often with one or
more insolvent policies in most if not all triggered years), this approach
would frequently become unworkable.
Accordingly, consistent with the logic of Farmers Mutual, insolvent
policies should be included in the calculation of the relevant pro-rata
shares. As discussed below, the pro-rata shares attributable to the insolvent policies are, under Farmers Mutual, the responsibility of the solvent
policies triggered by the claim.
B. Who Pays? In the Absence of “Drop Down” Coverage, the Solvent
Insurers That Issued Coverage Triggered by a Claim Must Pay for
an Insolvent Insurer’s Pro-Rata Share
The question of who pays for an insolvent insurer’s share presumably could
have resulted in one of four answers: (1) the Guaranty Association (as
Farmers Mutual unsuccessfully argued in Farmers Mutual); (2) the policyholder (as Zurich unsuccessfully argued in Farmers Mutual); (3) the solvent
insurer whose policy sits immediately above the insolvent insurer’s policy
(as the policyholder unsuccessfully argued in Werner); or (4) the solvent insurers that issued coverage triggered by a claim. After Farmers Mutual, the
answer is clear: in the absence of “drop down” coverage being provided by
the solvent policy sitting excess of the insolvent policy, the solvent insurers
that issued coverage in periods triggered by a claim must pay for a triggered
insolvent policy’s share.
First, the Farmers Mutual court explicitly held that the Guaranty Association was the “insurer of last resort” and hence could not be held liable
for the pro-rata share of the insolvent policies as long as solvent insurance
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Tort Trial & Insurance Practice Law Journal, Spring-Summer 2015 (50:3&4)
triggered by a claim remained available.46 As such, “the limits of the policies issued by solvent insurers ‘in all other years’ must first be exhausted
before the Guaranty Association is obligated to pay statutory benefits.”47
Second, the Farmers Mutual court explicitly rejected the argument, advanced by amicus curiae Zurich, that the policyholder should be responsible for the insolvent policy’s pro-rata share.48 The court reasoned that
the PLIGA Act’s purpose “ ‘to minimize financial loss to claimants or
policyholders because of the insolvency of an insurer’ . . . would be defeated by making the insured bear the loss for the carrier’s insolvency before the insured received any statutory benefits from the Guaranty Association.”49 Accordingly, given that the PLIGA Act created the Guaranty
Association “as a means of providing benefits to insureds that, through
no fault of their own, have lost coverage due to the insolvency of their carriers,” the court held that the policyholder was not responsible for the insolvent insurer’s pro-rata share.50
Third, the court had previously held in Werner that, based on the policy language at issue, the solvent excess policy sitting immediately above
the insolvent policy was not required to “drop down” and cover the prorata share allocable to that insolvent policy. Because all of the policies at
issue in Farmers Mutual were primary (with no excess coverage), the court
did not explicitly address this “drop down” issue.
Therefore, in the absence of “drop down” coverage being provided by
the solvent policy sitting excess of the insolvent policy, the court was necessarily holding that the solvent policies triggered by a long-tail claim are
responsible not only for their own shares but also for the shares attributable to the insolvent policies triggered by the claim. Hence, when a longtail bodily injury or property damage claim triggers both solvent and
insolvent policies, except in instances where “drop down” would be appropriate, the solvent policies triggered by a claim are to provide effectively two types of coverage, both calculated in conformity with OwensIllinois and its progeny. First, each solvent policy will be responsible for
its “traditional” pro-rata-weighted-by-limits share, which is to be calcu46. Id. at 863, 873–74.
47. Id. at 872 (quoting N.J. STAT. ANN. § 17:30A-5).
48. Id. at 873.
49. Id. (quoting N.J. STAT. ANN. § 17:30A-2).
50. Id. at 873–74 (emphasis added). While Zurich argued that the decisions in Spaulding
Composites and Benjamin Moore required that the policyholder bear responsibility for the
share attributable to an insolvent insurer, the statements in those decisions were mere
dicta since the court in those cases was not required to determine who was responsible for
an insolvent insurer’s share. Further, the Farmers Mutual court clarified that neither Spaulding Composites nor Benjamin Moore “involved the PLIGA Act or mentioned the Guaranty Association’s statutory obligation to stand in the shoes of the insurer to protect the insured on
certain claims up to a maximum of $300,000.” Id. at 866 n.2. Hence, Zurich’s reliance on
Spaulding Composites and Benjamin Moore was misplaced.
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765
Figure 3
lated as if all policies triggered by a claim were issued by solvent insurers.
Second, each solvent policy will also be responsible for its proportional
share of any insolvent policy’s pro-rata share.
For example, Figure 3 (which depicts the same coverage program as
Figure 2 described above) reflects the two types of shares that each of
the solvent triggered policies pays on a $1 million claim that triggers all
four years.
For the first share, the “traditional” share, the pro-rata-weighted-bylimits percentages of each year are straightforward: 10 percent ($100,000)
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Tort Trial & Insurance Practice Law Journal, Spring-Summer 2015 (50:3&4)
to Year 1, 20 percent ($200,000) to Year 2, 30 percent ($300,000) to Year 3,
and 40 percent ($400,000) to Year 4.
For the second share, the share that solvent insurers pay as they “stand
in the shoes of ” the insolvent insurer, the $200,000 allocable to the insolvent primary insurer in Year 2 is paid to the policyholder by the solvent
insurers that cover the claim in question—the primary insurers in Years
1, 3, and 4. These three policies share such $200,000 in a proportionate
manner consistent with the Owens-Illinois methodology, such that the
Year 1 primary pays 1/8th of the $200,000 ($25,000), the Year 3 primary
pays 3/8ths of the $200,000 ($75,000), and the Year 4 primary pays 4/8ths
of the $200,000 ($100,000).
In this manner, consistent with the purposes of the PLIGA Act, the
policyholder has not suffered any loss as a result of the insolvency of
the Year 2 primary insurer. Further, the Guaranty Association has not
been asked to provide benefits because the solvent coverage triggered
by the claim has not been fully exhausted. In addition, the Year 2 excess
policy has not been required to “drop down” (unless the language of the
policies so provides), consistent with Werner.
In sum, the reasoning in Farmers Mutual requires that, in the absence
of “drop down” coverage, the solvent policies triggered by a claim are responsible not only for their own pro-rata shares under Owens-Illinois’s
pro-rata-weighted-by-limits methodology, but also for the shares attributable to insolvent policies triggered by such claim.
C. How Are Payments Applied Against the Limits of Liability of the Triggered
Solvent and Insolvent Policies? Amounts That Solvent Insurers Pay on
Account of Their “Traditional” Share Serve to Erode Their Limits, While
the Amounts They Pay When “Standing in the Shoes of ” an Insolvent
Insurer Do Not and Instead Are “Credited” Against the Limits of the
Insolvent Policy for Purposes of Accessing Excess Coverage
As noted above, this article’s approach treats solvent insurers as functionally providing two types of coverage. The first type is the “traditional”
pro-rata-weighted-by-limits share that is calculated as if all of the triggered policies were issued by solvent insurers. The second type, which
treats solvent insurers as if they were “standing in the shoes of ” an insolvent insurer, is the solvent carrier’s proportionate share of any insolvent
insurer’s pro-rata-weighted-by-limits share. The principles and reasoning
underlying Owens-Illinois and its progeny, including Farmers Mutual, lead
to the conclusion that the amount paid on account of the solvent insurer’s
“traditional” share does serve to erode the limits of liability of the solvent
policy (as appropriate under its terms), while the amount paid by a solvent
insurer when “standing in the shoes of ” an insolvent insurer does not;
rather, such “standing in the shoes” amount is credited against the limits
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767
of the insolvent policy’s limits (as appropriate under its terms) for purposes
of accessing the coverage excess of such insolvent policy.51
As an example, as depicted in Figure 3 above, the Year 4 primary policy
pays $500,000, consisting of two different types of coverage:
• The Year 4 primary policy pays $400,000 for its “traditional” pro-rata-weightedby-limits share. The $400,000 “traditional” share erodes the Year 4 primary
policy’s limits of liability (assuming that policy’s terms so provide). For instance, if the $400,000 is on account of defense costs, and the Year 4 primary policy provides that defense costs are payable “within limits” (as opposed to being payable “in addition to” or outside of the limits of liability),
then the $400,000 payment would erode that policy’s applicable limits of
liability.
• The Year 4 primary policy pays $100,000 for its proportionate share of the Year 2
insolvent primary policy’s $200,000 share. Despite paying this amount, the
Year 4 primary policy’s limits are not reduced by this $100,000 amount.
Rather, for purposes of accessing the excess coverage sitting above the insolvent policy, the $100,000 is attributed to the Year 2 insolvent primary
policy’s limits (assuming that policy’s terms so provide), as are the
$25,000 and $75,000 paid respectively by the Year 1 and Year 3 primary
policies on behalf of the Year 2 primary policy. Hence, for purposes of accessing the Year 2 excess coverage, the Year 2 primary policy is treated as if
it has been impaired by its $200,000 pro-rata share calculated under the
Owens-Illinois methodology.
Since the insolvent policy is not actually paying, this “crediting” of the
insolvent policy’s limits is solely for purposes of establishing underlying
“exhaustion” so that the solvent Year 2 excess policies may be accessed.
In other words, when $1 million of payments have been made by the solvent carriers on behalf of the Year 2 insolvent policy (assuming all such
payments are for losses that the Year 2 policy agrees reduce its limits),
the insured may begin to access the Year 2 first-layer excess policy, having
satisfied that policy’s requirement that the Year 2 primary policy be “exhausted.”52 As discussed above, if the insolvent policy’s limits are not
credited in this or a similar fashion, it arguably may hinder or even preclude the insured from being able to access the solvent coverage that is
51. The insolvent policy’s limits are not actually impaired since the insolvent will not have
paid any money in this situation. However, its limits need to be “credited” for purposes of
accessing the excess coverage sitting above the insolvent policy. Otherwise, in the absence
of such credit, the excess insurers would argue that there was no exhaustion of the coverage
underlying their policies, as (they would argue) their policies require.
52. Of course, the Year 2 primary insurer has not actually paid any amounts and hence the
solvent insurers that have paid the insolvent’s share presumably may seek to assert contribution or subrogation claims against the insolvent’s estate, subject to the laws governing the
Year 2 primary insurer’s insolvency proceedings (and may seek recovery from the Guaranty
Association if the solvent insurance is exhausted).
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excess of the insolvent policy, an unreasonable and absurd result that
would simply grant a windfall to such excess carriers.
In short, under this article’s approach, the solvent insurers could end
up paying more than their policy limits because the amounts that they
pay on account of the insolvent insurer’s share do not erode such limits.
The solvent insurers that are paying the insolvent insurer’s share can be
expected to complain about such result and argue that the amounts
they pay on behalf of insolvent insurers should erode the limits of the solvent policies. That argument is inconsistent with the PLIGA Act and the
reasoning of Famers Mutual.53
First, the fact that the solvent insurers are providing two types of
coverage—one on account of their own coverage and one on account of
the insolvent coverage—is wholly consistent with the premiums often
paid by the policyholder. Policyholders are frequently charged not only
a premium for the solvent insurer’s limits of liability but also a separate
“premium surcharge” that is ultimately tied to the risk of other insurers
becoming insolvent. In fact, the Farmers Mutual court cited specifically
to such premium surcharges in noting that “[t]he Guaranty Association
is empowered to assess members in amounts necessary to pay the covered
claims of an insolvent insurer” and that “[t]he assessments are recouped by
insurance carriers, which pass them on to insureds as a policy premium
surcharge.”54 The insurance industry and regulators are in a better position than a policyholder to project the likelihood of insurer insolvencies
and hence it is economically more efficient to have the insurance industry
calculate, internalize, and redistribute those costs through premium surcharges. Thus, as the policyholder functionally is paying for two different
coverages, it is reasonable for the solvent carrier to provide those two coverages and thereby to bear the costs of insurer insolvency.
Second, the approach advocated in this article—that payments made by
a solvent insurer on behalf of an insolvent policy should be credited only
53. Similarly, the solvent insurers may argue that this article’s approach would allow the
policyholder to recover more than it would if none of the insurers had become insolvent because, in addition to recovering from the solvent insurers (on account of both their own policies and the insolvent insurer’s policies), the policyholder could purportedly seek to recover
from the Guaranty Association. That is incorrect. Under this article’s approach, the solvent
insurers would be putting the policyholder in the same position that it would have been if no
insurer had become insolvent (thus satisfying the policy goal of the PLIGA Act of minimizing the financial impact of insurer insolvency on policyholders). As a result, if the policyholder has received the full benefits on account of the insolvent insurer’s policies that it
would have been entitled to if that insurer had not become insolvent, the policyholder
would have no out-of-pocket damages attributable to such insolvent policies from which
to seek recovery from the Guaranty Association. Hence, under that scenario, the policyholder would not be able to assert a claim against the Guaranty Association.
54. Farmers Mut., 74 A.3d at 870–71 (internal quotation and citations omitted). See notes
6 and 43 and accompanying text, supra.
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769
to that insolvent policy’s limits and should not erode the solvent policy’s
limits—is true to the scope of coverage purchased by the policyholder.
For instance, assume that the Year 2 insolvent primary policy provided
coverage for defense costs “in addition to limits” while the Year 4 primary
policy provided coverage for defense costs “within limits.” An “in addition
to limits” policy may be required to cover limitless defense costs and
hence such coverage is more expensive, all else being equal, than a “within
limits” policy. If (as in the hypothetical above) the Year 4 primary policy
pays $100,000 in defense costs on account of the Year 2 insolvent primary
policy, the Year 4 insurer would argue that such $100,000 reduces the
Year 4 primary policy’s limits because such policy pays defense costs
“within limits.” But this would undermine the purpose of the PLIGA
Act to minimize the losses to the policyholder caused by insurer insolvency. Having bought the more expensive “in addition to limits” coverage
for Year 2, the policyholder would lose part of the benefit of its bargain if
its “in addition to limits” coverage was functionally replaced by Year 4’s
“within limits” coverage.
Likewise, if the coverage was reversed such that the Year 2 primary
policy provided “within limits” coverage and the Year 4 primary policy
was “in addition to limits,” the Year 4 primary insurer would receive a
windfall if its limits of liability could be reduced by defense costs that it
paid on behalf of the Year 2 insurer.55
Thus, the appropriate result is to honor the coverage actually purchased by the policyholder and to require the solvent insurers to truly
stand in the shoes of the insolvent insurer, including whatever terms govern the insolvent policy.
Third, the solvent insurers’ position would cause the amounts that they
pay on behalf of the insolvent insurer to be double counted. For instance,
when the Year 4 primary policy pays $100,000 on behalf of the Year 2 insolvent policy, the Year 4 insurer would contend that such $100,000 impairs the Year 4 policy’s limits. But that $100,000 is also being “credited”
against the Year 2 insolvent policy’s limits (for purposes of accessing the
solvent excess coverage in Year 2). Double counting that $100,000 payment (by eroding the solvent Year 4 primary limits while also crediting
the insolvent Year 2 primary’s limits) would lead to absurd results.
For example, as depicted in Figure 4, assume that an insurance program contains two relevant years, with Year 1 having a $2 million solvent
primary policy, a $1 million insolvent first-layer excess policy, and a
$1 million solvent second-layer excess policy, while Year 2 has a $1 million
55. Similar problems arise when there are other differences in the scope of coverage provided by the solvent and insolvent policies, such as when one policy provides an aggregate
limit for a type of hazard or cost and the other policy does not.
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Tort Trial & Insurance Practice Law Journal, Spring-Summer 2015 (50:3&4)
Figure 4
insolvent primary policy, a $2 million solvent first-layer excess policy, and
a $1 million solvent second-layer excess policy.
Assume that a $2 million payment triggers both years and hence that
the “traditional” shares would be $1 million to each year. The Year 1 primary would pay $2 million—$1 million for its “traditional” share and
$1 million on account of the Year 2 primary. If such amounts are “double
counted” and credited against both the Year 1 and Year 2 primaries, the
Year 1 primary would be exhausted and the Year 2 primary, while not actually exhausted,56 would be credited as having been exhausted for purposes of accessing the Year 2 excess coverage. Assume that a second
$2 million payment is incurred and triggers both years, and thus the “traditional” shares again would be $1 million to each year. The Year 2 firstlayer excess would pay $2 million—$1 million for its “traditional” share
and $1 million on account of the Year 1 first-layer excess. Again, if
these amounts were “double counted,” they would exhaust the Year 2
first-layer excess policy, while crediting the Year 1 first-layer excess as
having been exhausted for purposes of accessing the Year 1 second56. Because the Year 2 primary would not have paid any actual money, its limits would
remain available for any claims asserted against it in its insolvency proceedings or otherwise.
New Jersey’s Allocation Law, Insolvent Insurers, and Long-Tail Claims
771
layer excess. The next claim that came in the door would be able to access
the second-layer excess in both Year 1 and Year 2—policies that sit collectively over $6 million in underlying coverage—even though the policyholder had only incurred $4 million in losses to date. The “double counting” of the solvents’ payments on account of the insolvents would be
inconsistent with the attachment points of the excess policies.
In short, it would be contrary to the notion that a solvent insurer is
“standing in the shoes of ” an insolvent insurer if such payments it
makes on account of the insolvent insurer are credited against the insolvent’s limits while also eroding the solvent’s limits.
Fourth, the solvent insurers are not without recourse. Having paid
amounts on behalf of the insolvent insurers, the solvent insurers presumably may seek to assert contribution or subrogation claims against the insolvent insurer, subject to the laws governing that insurer’s insolvency
proceedings and may seek recovery from the Guaranty Association if
the solvent insurance is exhausted. Because the insolvent insurer did not
actually pay in the above examples, its limits would remain available for
any claims that the solvent insurers could assert against it.
Fifth, permitting the solvent insurers that happened to exhaust their
“traditional” limits of liability to escape their proportionate share of the
“standing in the shoes” coverage may result in inequitable results for
those solvent insurers whose “traditional” limits do not happen to be exhausted. For instance, as illustrated in Figure 5 (which depicts the same
coverage program as Figures 2 and 3 described above), assume that a
$7.6 million claim triggers all four years in a program.
For the first share, i.e., the “traditional” share, the pro-rata-weightedby-limits approach results in four solvent policies exhausting their $1 million limit (the primary and first excess policies of Years 3 and 4), while the
other four triggered solvent policies only pay a portion of their limits
(from a low of just $40,000 by the Year 4 third excess policy to a high
of $760,000 for the Year 1 primary policy).
For the second share, i.e., the share that the solvent insurers pay as they
“stand in the shoes of ” the insolvent policies (which, but for their insolvency, would have been allocated $2 million in this scenario), this article’s
approach would impose a proportionate share on all eight solvent policies
reflecting the degree of risk they assumed on such claim. As illustrated in
the column in Figure 5 entitled “Share on Account of Insolvencies (If
Such Amounts Do Not Erode Solvent Limits),” this approach implicates
the solvent policies in the same proportion as their “traditional” share,
making it consistent with the Owens-Illinois allocation approach.
In contrast, if the four solvent insurers whose $1 million limits were
exhausted by their “traditional” share were permitted to escape any responsibility for the “standing in the shoes” share of the insolvent insurers,
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Figure 5
the remaining four solvent policies would not only be allocated a dramatically higher share, but the distribution of that share would likely be inequitable. For instance, as illustrated in the column in Figure 5 entitled
“Share on Account of Insolvencies (If Such Amounts Do Erode Solvent
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773
Limits),” the Year 1 primary policy would be able to limit its liability to
just $240,000, thus shifting substantially more dollars to later years simply
because the solvent insurers in the later years had more limits available.
The Year 2 first excess and Year 3 second excess policies would similarly
exhaust, ultimately pushing an enormously larger share to the Year 4 third
excess policy. In effect, by allowing the shares that they pay on account of
insolvents to erode their limits of liability, the lower-lying policies and the
policies that happen to be in years with lower overall limits would benefit
at the expense of higher-attaching policies and policies that happen to be
in years with higher overall limits. All else being equal, one would expect
lower-attaching policies to have assumed a greater degree of risk than
higher-attaching policies, and hence this approach would be inconsistent
with the Owens-Illinois approach. In short, there would likely be numerous
scenarios in which, if the solvent insurers were permitted to erode their
limits of liability based on their payments on account of insolvent shares,
certain solvent insurers would benefit at the expense of other, often
higher-attaching, solvent insurers, with no clear basis in New Jersey public policy or the Owens-Illinois approach to justify such a result.
Sixth, while the solvent insurers may allege that this article’s approach,
which exposes them to liability potentially in excess of their policy limits,
violates their preexisting contractual rights in violation of the U.S. and
New Jersey Constitutions, the Farmers Mutual court rejected a similar argument.57 To support such a claim, the solvent insurers would need to establish that this approach (1) “substantially impair[s] a contractual relationship,” (2) “lack[s] a significant and legitimate public purpose,” and
(3) is “based upon unreasonable conditions [that are] unrelated to appropriate governmental objectives.”58 Such an argument would fail. First, this
article’s approach would not substantially impair contractual relationships
between insurers and their policyholders because the solvent insurers have
recourse against the estate of the insolvent insurers or the Guaranty Association when all solvent coverage is exhausted. Second, the approach has a
“significant and legitimate public purpose” because it conforms to the
stated purposes of the PLIGA Act to minimize financial loss to claimants
or policyholders because of the insolvency of an insurer as well as avoiding
excessive delay in payment of covered claims.59 Third, the approach’s
conditions are reasonable and directly related to appropriate governmental objectives contained in the PLIGA Act because (1) “[t]he creation
of the Guaranty Association was a reasonable policy choice to achieve
th[e] important governmental objective” of “minimiz[ing] financial loss
57. Farmers Mut., 74 A.3d at 874–75.
58. Id. at 874 (first two sets of brackets in original).
59. N.J. STAT. ANN. § 17:30A-2.
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to claimants or policyholders because of the insolvency of a property or
casualty insurer” and (2) “[t]he Legislature intended the Guaranty Association to serve as a payor of last resort, understanding that the Guaranty
Association’s resources are limited and must be conserved to best achieve
the goal of the PLIGA Act.”60
Finally, in arguing that their payments on account of insolvent insurers
should erode the solvent insurers’ own policies’ limits, the solvent insurers
may point to the following passing statement by the New Jersey Supreme
Court in Farmers Mutual: “Moreover, Farmers Mutual has not been required to pay beyond the maximum policy limits that it insured in each
of the two cases. The risk it assumed in issuing those policies is that it
would be liable for environmental damage not to exceed $500,000 while
it was on the risk. The 2004 amendment does not upset that contractual
assumption.”61 This article’s approach is consistent with this dicta in
Farmers Mutual:
• First, this article’s approach does respect and enforce the limits of liability
of the policies. The solvent insurers are not being asked to pay for a prorata-weighted-by-limits share that exceeds their limits of liability. This article’s approach simply recognizes that the solvent insurers, in addition to
the coverage owed under their own policies, must also stand in the shoes of
the insolvent policies implicated in claims on which the solvent insurers
owe coverage. Any payments by the solvent insurers on account of an insolvent policy are to be credited against the limits of liability of that insolvent policy, and the solvent insurers’ obligations for such insolvent policy
cease when the insolvent policy’s limits have been fully credited. Thus, the
limits of liability of both the solvent and insolvent insurers’ policies are
fully respected and enforced. Consistent with the policy goals of the
PLIGA Act, the policyholder is put in the same position as it would
have been if no insurer implicated by a claim had become insolvent.
• Second, in the dicta quoted above, the Farmers Mutual court was not being
asked to determine whether amounts that a solvent insurer pays on account
of insolvent insurers do or do not erode the solvent policy’s limits. Rather,
the court was addressing the distinct issue of whether the 2004 amendment
was an unconstitutional impairment of Farmers Mutual’s preexisting contractual rights.
Third, the statement in Farmers Mutual is mere dicta since it was unnecessary to the court’s conclusion that the 2004 amendment was not an unconstitutional impairment of Farmers Mutual’s preexisting contractual
rights. The court noted that Farmers Mutual would need to establish
three elements—(1) that the legislation substantially impaired a contractual relationship, (2) that the legislation lacked a significant and legitimate
public purpose, and (3) that the legislation is based upon unreasonable
60. See Farmers Mut., 74 A.3d at 875 (internal quotations omitted).
61. Id.
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conditions and is unrelated to appropriate governmental objections—and
found that not even one of these had been proven.62 For instance, the
court found that Farmers Mutual failed to establish the second and third
prongs, as “the PLIGA Act—inclusive of the 2004 amendment—is motivated by ‘significant and legitimate’ public policy goals and imposes ‘[]reasonable conditions’ related to ‘appropriate governmental objectives.’ ”63
Similarly, Farmers Mutual failed to prove the first prong, as requiring it
to pay for amounts that would have been allocable to an insolvent insurer
did not constitute a “substantial impairment” of its contractual rights. The
court relied primarily on the fact that insurance is a heavily regulated industry, that insurers have been on notice that the Owens-Illinois methodology is a work in progress, and that the court had not had the opportunity
to resolve the interplay between that methodology and the PLIGA Act before.64 As a final, passing comment in this discussion, the court made the
statement quoted above regarding the limits of Farmers Mutual’s policy.
This language was unnecessary to the court’s conclusion that Farmers Mutual had not established a “substantial impairment” under the first prong.
• Fourth, this article’s approach, i.e., requiring the solvent insurers to pay for
amounts allocable to insolvent insurers and for such amounts to be credited
against the limits of the insolvent policies rather than against the solvent
policies’ limits, is not based on the 2004 amendment but rather on, inter
alia, the purposes of the PLIGA Act itself that supported its original enactment. Thus, the above dicta noted by the court in addressing whether the
2004 amendment was an unconstitutional impairment of Farmers Mutual’s
preexisting contractual rights does not bear on this article’s approach.
• Finally, even assuming arguendo that this dicta in Farmers Mutual could
somehow be read to hold that Farmers Mutual could not have been required to pay more than its policy limits, such a reading would fail to
take into account the ramifications for such an approach in more complex
insurance programs. Farmers Mutual only dealt with a simple scenario involving two primary insurers, one solvent and one insolvent, and no excess
coverage. As explained in the examples given in this article, in cases involving multiple layers of coverage with insolvent policies interspersed
throughout (as is common in the historical programs of larger corporate
policyholders), permitting a solvent insurer to reduce its limits by any
amounts that it pays on behalf of an insolvent insurer would lead to unreasonable results. Indeed, not only would such an approach prejudice the
policyholder, but it would likely also shift a disproportionate amount of
the risk to other solvent insurers that happened to be implicated by the
claim but did not have the good fortune of being close to having exhausted
their limits.65
62. Id. at 874–75.
63. Id. at 875 (quoting State Farm Mut. Auto. Ins. Co. v. State, 590 A.2d 191, 208 (N.J.
1991)).
64. Id. at 874–75.
65. See supra notes 54–57 and accompanying text, including Figure 5.
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Thus, the solvent insurers may not avoid the approach advocated in
this article based on the dicta in Farmers Mutual, noting that the solvent
insurer had not paid more than its policy limits.66
In sum, the solvent insurer should be required to provide two types of
coverage, one on behalf of its own policy’s coverage (which amounts may
serve to reduce its limits of liability, to the extent that the solvent policy’s
terms so provide) and the other on behalf of the insolvent insurer (which
amounts do not serve to reduce the solvent policy’s limits of liability).
v. this article’s approach is supported by new jersey
public policy, the principles underlying new jersey
insurance law, and the purposes of the pliga act
The approach proposed in this article is consistent with the public policies and principles underlying New Jersey law on insurance coverage
for asbestos and environmental loss as well as the purposes of the
PLIGA Act.
First, this article’s approach is supportive of New Jersey’s public policy
of making the most efficient use of available resources to cope with damage caused by long-tail liabilities.67 This approach both maximizes the
amount of resources available to deal with such losses and satisfies the
goals of the PLIGA Act by ensuring that the loss to policyholders caused
by the insolvency of one of its insurers is minimized.68 Further, by treat-
66. Similarly, the solvent insurers will point to general statements in Benjamin Moore that
discuss the application of policy limits to an insurer’s pro-rata-weighted-by-limits share:
[O]nce the amount of loss allocable to the policy period is determined, it is to be treated
exactly as any actual loss during that period would be treated in accordance with the policy
provisions, including limits and exclusions.
Important as well in assessing Benjamin Moore’s allocation of deductibles proposal is
that Owens-Illinois does not affect the insurance limits in any year of coverage. Those limits
remain as contracted for and are fully available to the insured.
Benjamin Moore & Co. v. Aetna Cas. & Sur. Co., 843 A.2d 1094, 1105 (N.J. 2004). Again,
this article’s approach is consistent with these statements, as it reflects the limits of coverage
purchased by the policyholder under both the solvent and insolvent insurers’ policies. The
approach is intended to put the policyholder in the same position that it would have been
if none of its insurers had become insolvent and enforces both the solvent policies’ limits
with respect to their traditional pro rata share and the insolvent policies’ limits with respect
to the “standing in the insolvents’ shoes” share paid by the solvent insurers. Both of those
limits remain as contracted for and are fully available to the policyholder. At any rate, Benjamin Moore did not address the issue here of how to handle shares allocable to insolvent insurers and therefore the above statements do not support a solvent insurer’s attempt to avoid
the ramifications of the Farmers Mutual decision.
67. E.g., Owens-Illinois, Inc. v. United Ins. Co., 650 A.2d 974, 992 (N.J. 1994); CarterWallace, Inc. v. Admiral Ins. Co., 712 A.2d 1116, 1124 (N.J. 1998).
68. See N.J. STAT. ANN. § 17:30A-2.
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ing the Guaranty Association as the insurer of last resort, its funds will be
conserved, consistent with the legislature’s goal.69
Second, the article’s approach is consistent with New Jersey’s principle
of promoting simple justice, including “not permitting excess insurers unfairly to avoid coverage in long-term, continuous trigger cases.”70 As discussed above, the approach honors the coverage actually purchased by the
policyholder. Further, if an insolvent policy were not included in the calculation of pro-rata shares, there would apparently be no amount allocated to the insolvent policy. As a result, the solvent insurers sitting
above such an insolvent policy would argue that their coverage may
never be attached, potentially giving them an undeserved windfall enabling them to avoid providing coverage that should otherwise be
available.
Third, the article’s approach promotes certainty and predictability.71
Simply put, under this approach, no matter when an insolvency strikes
or where the insolvent policy sits in the coverage program, the allocation
methodology remains consistent and therefore satisfies the Supreme
Court of New Jersey’s directive in Owens-Illinois to eliminate shifting configurations of coverage.72 Without this approach, the pro-rata percentages would necessarily change each time a triggered insurer became insolvent; such a result would be absurd and arbitrary and would significantly
increase the complexity and difficultly of the allocation calculation methodology with no clear benefit to policyholders or their insurers.
Fourth, this article’s approach honors the terms of coverage provided
under both the solvent and insolvent policies.73
Fifth, by applying the same Owens-Illinois approach whether a program
does or does not involve insolvencies, the article’s approach ensures the
selection and consistent application of a single allocation method as prescribed by the New Jersey Supreme Court.74
Sixth, as compared to other approaches rejected by the Farmers Mutual
court, the article’s approach is simpler and hence promotes New Jersey’s
goal of choosing an approach that is “administratively manageable” and
“can be applied with minimal need for litigation.”75
69. Farmers Mut., 74 A.3d at 871 (recognizing that the Guaranty Association’s “resources
must be conserved to achieve the Act’s core purposes”).
70. Carter-Wallace, 712 A.2d at 1124; see also Spaulding Composites Co. v. Aetna Cas. &
Sur. Co., 819 A.2d 410, 417 (N.J. 2003) (citing Owens-Illinois, 650 A.2d at 992).
71. Carter-Wallace, 712 A.2d at 1124.
72. Owens-Illinois, 650 A.2d at 991 (“To have shifting rules of interpretation that depend
on the configuration of insurance coverage is unacceptable to us.”).
73. See supra Part IV.C.
74. See Carter-Wallace, 712 A.2d at 1124.
75. Owens-Illinois, 650 A.2d at 993 (quoting Ins. Co. of N. Am. v. Forty-Eight Insulations,
Inc., 633 F.2d 1212, 1218 (6th Cir.1980), clarified in part, 657 F.2d 814 (6th Cir. 1981)).
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Seventh, this article’s approach promotes New Jersey’s well-established
public policy of encouraging settlement.76 For instance, by consistently
using the Owens-Illinois pro-rata methodology for calculating allocation
shares, the article’s approach enhances the predictability of the triggered
insurers’ shares and hence enhances the ease of settling such insurers’
responsibilities.
Eighth, the article’s approach is consistent with the policyholder’s reasonable expectations by ensuring that they receive the coverage they
bought regardless of whether or when insolvencies arise.77
Ninth, the insurance industry and regulators are in a better position
than policyholders to evaluate the likelihood and impact of insurer insolvencies. As such, it is more economically efficient for the industry to calculate and internalize those costs, bear the risk of insurer insolvencies, and
redistribute those anticipated costs through premium surcharges.
In sum, the approach advocated in this article is consistent with OwensIllinois and its progeny, including Farmers Mutual, the public policies and
rationales underlying those decisions, and the purposes of the PLIGA Act.
vi. conclusion
In Farmers Mutual, the Supreme Court of New Jersey clarified allocation
law in cases involving insolvent insurers and the PLIGA Act and presumably the Guaranty Fund Act as well. In light of the rulings and reasoning
of Farmers Mutual, New Jersey courts should apply the following allocation approach in cases involving one or more insolvent policies triggered
by a long-tail claim:
(1) the pro-rata-weighted-by-limits shares of all triggered insurers should
initially be calculated consistent with Owens-Illinois as if all triggered insurers were solvent;
(2) the solvent triggered insurers should be held liable for their “traditional”
pro-rata shares, with such payments eroding their limits of liability to
whatever extent their policy terms so provide;
(3) the solvent triggered insurers should be required to “stand in the shoes
of ” any insolvent triggered policies, such that the solvent insurers provide a second component of coverage that represents their proportionate
share of such insolvent policies’ pro-rata shares (also calculated in accordance with Owens-Illinois); and
(4) the amount paid by a solvent insurer on behalf of an insolvent insurer
does not erode the solvent insurer’s limits of liability; rather, such
amount is credited against the insolvent policy’s limits to whatever extent
76. See, e.g., Nolan ex rel. Nolan v. Lee Ho, 577 A.2d 143, 146 (N.J. 1990).
77. Selective Ins. Co. of Am. v. Hudson E. Pain Mgmt. Osteopathic Med., 46 A.3d 1272,
1277 (N.J. 2012).
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such policy’s terms provide (such credit is solely for purposes of satisfying the “underlying exhaustion” requirement in an excess policy sitting
above the insolvent policy and does not constitute actual exhaustion of
the insolvent policy’s limits, given that the insolvent will not have paid
any amounts).
This approach is easily workable, and comports with Owens-Illinois and
its progeny, including Farmers Mutual, the public policies and reasoning
underlying those decisions, and the purposes of the PLIGA Act and Guaranty Fund Act.