The North Carolina Supreme Court Rules for Pro Rata Allocation

December 20, 2022 | Insurance Coverage

In an issue of first impression in the state, on December 16, 2022, the North Carolina Supreme Court decided Radiator Specialty Co. v. Arrowood Indemnity Co., holding that pro rata, or time-on-the-risk, allocation applies to defense and indemnity costs in long-tail claim cases. The decision reverses a lower court decision allowing the insured to take “all sums” from any insurer of its choosing, and instead spreads the loss over periods of years or decades.  Allocation asks whether and how to spread insurable loss over the triggered policies. Policyholders ask for all sums allocation because it spares them the consequences of their prior decisions about risk transfer. Insurers seek application of pro rata allocation consistent with the limitation of coverage in policies for injury or damage which occurs “during the policy period.”

On this key coverage issue the Court explained, “[a]s the insurers argue, the modern trend is to apply pro rata allocation when limiting language like ‘during the policy period’ exists, even when the policy contains a reference to paying ‘all sums’ arising out of certain liabilities.” The Court concluded that “using Fireman’s Fund’s policies as an example, the insurer agreed to pay for all of the sums (1) arising from bodily injuries; (2) resulting from occurrences; and (3) that took place during the policy periods.” It found that “the language ‘during the policy period’ therefore cabins the phrase ‘all sums’ to a finite period of time.” From this, the Court decided that “the insurers did not agree to cover all sums arising out of benzene exposure without regard to the policy periods during which incidents of exposure took place. Instead, ‘[c]onsistent with the policy language limiting coverage to that which occurs ‘during the policy period,’ the timing of the [occurrence/injury] dictates … the portion of damages for which each policy is responsible.’”

The Court rejected the minority view, which applies the “all sums” approach, because “[t]hese cases … tend to represent an outdated view of the proper interpretation of ‘pro rata’ language,” and “[t]he truncated contractual interpretation they apply fails to fully consider the limiting effect of the phrase ‘during the policy period.’”

The Court concluded that an insured should bear the risk of its choices in buying insurance policies with high deductibles and self-insured retentions, buying policies from less financially secure insurers, losing its policies, and settling with certain insurers, which only happens with application of pro rata allocation.

The Court also addressed the policyholder community’s latest argument that other policy language, such as noncumulation clauses in underlying umbrella policies, are inconsistent with pro rata allocation, as found by the New York Court of Appeals in In re Viking Pump. Here, the Court examined the “following form” clause in the Fireman’s Fund standard excess policy form, which stated that the policy did not follow form to provisions relating to “the amount and limits of liability.” It concluded “non-cumulation and prior insurance provisions have a well-recognized purpose: to limit an insurer’s liability to a single policy limit when an occurrence triggers multiple policies issued by that insurer,” and “Fireman’s Fund’s excess policies at issue ‘expressly do not incorporate underlying provisions that relate to the amount and limits of liability’ like the non-cumulation provisions.” Thus, the Court held “the non-cumulation provisions are not incorporated into the umbrella policies in the first instance.” This is the first published decision on the issue in the country.

In addition, the Court also rejected the Viking Pump analysis, holding that “the language of the [noncumulation] clauses provides for their application where more than one policy is required to indemnify for the same loss, not where the policy is required to indemnify for a loss that occurred outside its policy period.” This, together with the construction of the following form clause, will provide the insurance industry with cogent arguments to oppose exportation of Viking Pump to other jurisdictions.

The result in the case is affirmance of a no-pay final judgment for Fireman’s Fund because indemnity costs, once prorated, don’t reach the excess policies’ attachment points, which apply excess over underlying policies’ limits.

This allocation ruling is also important to the insurance industry. The decision flips another state high court to the pro rata camp and continues the trend of courts in the past 20 years adopting pro rata allocation and provides a well-needed counterbalance to the Viking Pump end-around to pro rata allocation rulings.

The Court also adopted an exposure trigger, finding that bodily injury occurs during the period of a claimant’s exposure to benzene, and not during the period when a claimant later develops cancer and becomes sick.

Michael Kotula and Robert Maloney of Rivkin Radler LLP and Matthew Leerberg of Fox Rothschild LLP represented Fireman’s Fund Insurance Company.

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