A recent decision by the California Court of Appeal for the Second District grappled with the concepts of “horizontal exhaustion” and “stacking” of policy limits in the context of an insured attempting to tap excess policies in a case involving continuous losses spanning multiple policy periods. Kaiser Cement and Gypsum Corp. v. Insurance Co. of the State of Pennsylvania, 2011 Cal.App.LEXIS 686 (filed June 3, 2011), involved an increasingly familiar factual scenario in which thousands of bodily injury claims were brought against Kaiser arising out of asbestos products manufacturing activities in ten different Kaiser facilities operated from 1944 until the 1980s.

The court initially addressed coverage for these claims in its earlier opinion in London Market Insurers v. Superior Court, 146 Cal.App.4th 648 (2007) (“LMI”), where it held that the claims against Kaiser did not constitute a single annual “occurrence” within the meaning of policies issued by Truck Insurance Exchange, but were separate occurrences. 

In this new case, the court has taken on the formidable task of apportioning liability for continuing injuries among the insurers on the risk over time. This decision specifically addressed a primary layer policy issued by Truck to Kaiser covering the period from 1974 to 1981, which contained a $500,000 “per occurrence” liability limit, with no annual limit and no limit to the number of occurrences, and, in policy years 1974 and 1975, a $5,000 deductible for “each occurrence.” Kaiser had certain other Truck primary policies applicable to this time period, and also was insured by three additional primary carriers during the relevant period. It entered into cost sharing agreements with all the primary carriers. Eventually, all the carriers except Truck gave notice of exhaustion of their policies, leaving Truck as the only primary carrier continuing to pay defense and indemnity costs for the asbestos bodily injury claims. 

Truck filed for declaratory relief that its primary policies had been exhausted and that it had no further obligations to Kaiser. Kaiser responded by cross-claiming against its excess insurers, including Insurance Co. of the State of Pennsylvania (ICSOP), seeking a declaration that the excess insurers were obligated to defend and indemnify Kaiser with respect to the claims once the primary coverage was exhausted. 

After the LMI decision was rendered, Kaiser selected the 1974 Truck primary policy to respond to all claims applicable to that year, based on FMC Corp. v. Plaisted & Companies, 61 Cal.App.4th 1132 (1998). Based on FMC, Kaiser argued that the first-level umbrella policy issued by ICSOP incepting in 1974 which was directly above the Truck policy (as well as any excess policies directly above that one) was required to respond to claims, once Truck had paid and exhausted its $500,000 limit for that year. In FMC, the court held that in these continuing injury cases, the insured may “telescope” and select a single policy period in which the policy limits are fixed, and seek exhaustion up the vertical tower based on that policy year. That reasoning would have allowed Kaiser to tap the ICSOP policy directly above the Truck policy.

However, ICSOP disagreed. It argued for the rule of “horizontal exhaustion,” in which an excess policy is not triggered until the liability limits of all primary policies during the continuing loss period have been exhausted. The ICSOP policy provided indemnity for Kaiser’s “ultimate net loss in excess of the retained limit hereinafter stated” up to $5 million “as the result of any one occurrence.” The “retained limit” was “an amount equal to the limits of liability indicated beside [sic] the schedule of underlying policies plus the applicable limit(s) of any other underlying insurance collectible by the Insured.”

Ultimately, it was the italicized language that convinced the court to adopt ICSOP’s position. The court rejected Kaiser’s interpretation of “underlying” as limited to the immediately underlying policy (i.e., the Truck policy). As a result, following Community Redevelopment Agency v. Aetna Casualty & Surety Co., 50 Cal.App.4th 329 (1996); and Stonewall Ins. Co. v. City of Palos Verdes Estates, 46 Cal.App.4th 1810 (1996), the court held that Kaiser was required to exhaust all primary policies – horizontally– before it could trigger the ICSOP policy. This was not surprising, since the horizontal exhaustion rule is now widely accepted. It stands in contrast to vertical exhaustion, which is allowed only if an excess policy states that it is excess to a specifically defined and limited primary policy.

The court then applied the concept of “stacking” to the situation. The limits of liability provision provided "[t]he limit of liability stated in this policy as applicable `per occurrence' is the limit of the company's liability for each occurrence" and "the limit of the Company's liability as respects any occurrence . . . shall not exceed the per occurrence limit designated in the Declarations." The Court emphasized that this language “says that the per occurrence limit is the limit of the company's liability.” The court therefore held that Kaiser could not “stack” the liability limits of Truck’s primary policies, but could recover only up to the “per occurrence” limit of one policy, thus a maximum of $500,000. In doing so, the court adopted the positions taken by Kaiser and Truck, and rejected ICSOP’s position in favor of stacking for each year of the Truck policies. The result was that “Kaiser may recover from ICSOP to the extent that a claim exceeds that $500,000 per occurrence limit specified in the 1974 primary policy.” The court’s decision was based on the 1974 policy language, rather than a “generalized ‘anti-stacking’ rule,’” though it cited FMC and several other authorities.

Purely on principle, policyholders may be concerned about the court’s anti-stacking stance, because it reduces policy limits available to insureds as to multi-year policies, and arguably thereby gives insurers an unfair windfall. It also arguably is inconsistent with the “all sums” principle developed pursuant to Montrose Chemical Corp. v. Admiral Ins. Co.,10 Cal.4th 645 (1995); and Aerojet-General Corp. v. Transport Indemnity Co., 17 Cal.4th 38 (1997).

On further examination, the court’s position raises interesting questions about the relationships and competing equities between and among an insured and its insurers, including the potential tension between primary and excess insurers. Thus, while the court required horizontal exhaustion, consistent with the California case law in continuing injury situations, increasing the hurdles which Kaiser had to overcome before triggering the excess coverage, it also rejected stacking the policies issued by Truck, which had the impact of shrinking the horizontal timeline and making it easier for Kaiser to tap the excess policy. The court’s position also benefited the primary insurer to the detriment of the excess insurer. The benefits and detriments of this approach depend on the facts specific to a given case, and the relationships between and among the insured and the insurers on the risk. It cannot be said that the holding is bad for policyholders in every case.

The competing equities involved in application of a horizontal exhaustion rule with an overlay of stacking was reflected in the depublished opinion in State of California v. Continental Ins. Co., 170 Cal.App.4th 160 (2009), rev. granted, ordered depublished:

Technically, the horizontal exhaustion rule only governs the relationship between the primary and excess insurers. Nevertheless, it necessarily implies that the insured, too, is entitled to stack the primary policies; otherwise, the primary policies would never be exhausted. (See Iolab Corp. v. Seaboard Sur. Co. (9th Cir. 1994) 15 F.3d 1500, 1504 [applying California law; insured was not entitled to indemnity from excess insurers because it had not yet exhausted all primary policies].

In Iolab, the excess insurers were in the position of arguing for stacking of primary policies, just as in the Kaiser case, based on the idea that the insured had the right to stack policies to maximize coverage. The excess insurers’ concerns for the insured’s rights are commendable, but clearly the excess insurers’ self-interest was the primary motivating factor.

The Kaiser decision also raises questions about a single insurer as compared with multiple insurers on the primary layer. The decision can be criticized on the grounds that it leads to inconsistent results when multiple insurers are on the primary layer over time, rather than a single insurer. In the multiple insurer situation, stacking of a single carrier’s limits is not involved, and each insurer must pay up to its limits. This contrasts with the single insurer situation, where an anti-stacking rule adopted by the Court results in an insurer paying only a single limit – even if the policy language is identical. 

The future of this case and others involving allocation, such as Continental, is hard to predict, but one thing is certain – the courts will continue their efforts to refine the law applicable to the complex allocation issues presented by continuing loss cases. We may hope that, in doing so, they will arrive at clearer rules that are easier to apply – benefiting insureds and insurers alike.