1. The 4 Types of Confusion

A. Payment vs Ascertainment Confusion
Standard LSW 055 clause 1 says excess attaches only after underlying has paid, admitted liability, or been held liable for full indemnity. Does "held liable" mean court judgment against insured, or judgment against underlying insurer?

B. Order of Erosion Confusion
If you have 10 losses: 5 US losses of $2m each, 5 non-US losses of $2m each, with different sub-limits, which loss hits which layer first? Erosion order changes attachment.

C. Top and Drop Confusion
"Top and drop" excess policy is one which drops down to fill gaps if underlying fails to pay. Does wording change normal order?

D. Horizontal vs Vertical Exhaustion Confusion
If you have primary policies 2005-2010 each $10m, and a 2008 claim of $25m, do you need to exhaust all primaries from 2005-2010 ($60m) before excess attaches (horizontal), or just 2008 primary ($10m) (vertical)?

2. Landmark Case Laws

CASE 1: Teal Assurance v W R Berkley Insurance & Aspen Insurance - UK Supreme Court Trilogy - The Leading Case

Facts: Black & Veatch (US architects) had worldwide professional indemnity tower: Primary + 5 excess layers. Each excess layer included standard LSW clause: "liability shall not attach until underlying has paid, admitted liability or been held liable". BV had US losses ($ where US law applied) and non-US losses. US losses had sub-limit. Dispute: In what order do losses erode tower? Does non-US loss first erode primary, pushing US loss up to higher layers where sub-limit bites?

High Court EWHC 91 Comm: Said attachment is based on when liability arises, not when paid.[2011]

Court of Appeal EWCA Civ 1570: Confirmed commercial common sense of top and drop policy was for policies within tower to be exhausted in orderly manner depending on when liability was established against insured. Top and drop wording did NOT affect order. Cover is not burned through layers according to when insurers paid or admitted liability. Cover is burned through layers sequentially in accordance with Post Office v Norwich Union 1967.[2011]

Supreme Court UKSC 57 - Final on Order:
Reaffirmed ascertained losses ordered in chronological sequence when determining erosion. Each excess layer liability does not arise until underlying liability ascertained. Losses attach in order they were ascertained/incurred - meaning non-US losses to be applied to tower before US losses. This meant higher layers not reached by US sub-limited losses.[2013]

Principle for Confusion: Attachment point is triggered by ascertainment of liability (judgment/settlement with insured), not by payment by underlying insurer. And erosion is chronological order of ascertainment, not payment.

CASE 2: Ali v Federal Insurance Co., 2nd Cir 2013 WL 2396046 - US Opposite View - Payment Required

Facts: D&O tower for Commodore International. Excess policies said "shall attach only after all Underlying Insurance has been exhausted by payment of claim(s)."

Underlying insurers insolvent, did not pay, but liability clearly exceeded attachment.

Second Circuit: Coverage under excess policy triggered when underlying limits exhausted by actual payment, not merely accrual of liability. Mere liability insufficient. Excess not triggered despite insolvency.

Distinguished venerable Zeig v Massachusetts Bonding & Ins Co 23 F.2d 665 (2d Cir 1928) - Zeig allowed settlement below limits to constitute exhaustion if excess consented, but Zeig policy said "exhaustion by payment" vs Ali policy said "exhausted by payment of losses". Zeig is still good law: Insured can settle with underlying for less than limits and gap-fill, if excess does not object unreasonably.

Principle: If wording says "payment", US courts require actual payment. If wording says "exhaustion by payment of loss" vs "exhaustion of limits", difference matters.

CASE 3: Montrose Chemical Corp v Superior Court (2020) 9 Cal.5th 215 - Montrose III - Horizontal vs Vertical

California Supreme Court: Absent express wording, vertical exhaustion applies to primary + first-layer excess. You do NOT need to exhaust all primary years to trigger one year's excess.

If attachment point confusion says "$10m excess", it means that year's primary, not all years. If insurer wants horizontal exhaustion, must say "all underlying insurance in all policy periods must be exhausted".

This overturned decades of California horizontal exhaustion doctrine.

Santa Fe Braun v Insurance Co of North America (Cal App 2020): Applied Montrose III - first-layer excess attaches after that period's primary exhausted, not all primaries.

CASE 4: AXIS Reinsurance Co v Northrup Grumman Corp 975 F.3d 840 (9th Cir 2020) - Improper Erosion

Facts: Northrup had tower, underlying insurer allegedly wrongly paid a claim, thereby exhausting underlying layer and exposing AXIS Re higher layer to potential claims.

9th Circuit: Addressed "improper erosion" - situation where insurer is alleged to have wrongly paid claim, result was to use up underlying layer, exposing reinsurer. Court held reinsurer can challenge underlying payment as not covered, thus attachment point not truly reached. Reinsurer not bound by cedent's erroneous payment.

Principle: Attachment point is not reached by any payment, but by covered payment. If underlying payment was not for covered loss, it does not erode tower.

3. Why Confusion Happens - Drafting Traps

Trap 1: Drop Down Language
"Top and drop" policy - wording: "This policy will drop down to pay in event underlying fails to pay". Court of Appeal in Teal held this does NOT change normal order of attachment. It only applies if underlying insolvent, not if underlying disputes coverage.

Trap 2: "Pay or be held liable"
LSW 055 has two clauses. Clause 1: Underlying must have paid/admitted/been held liable. Clause 2: Underlying deemed to have paid if insured insolvent. Must read together. If you only read clause 1, you think payment needed. Read with clause 2, ascertainment enough.

Trap 3: Aggregate vs Per Occurrence Attachment
Excess may have per occurrence attachment $5m and aggregate attachment $10m. If you have 3 occurrences each $4m = $12m total, per occurrence attachment not reached ($4m < $5m), but aggregate attachment confusion: Does aggregate attachment erode by each occurrence regardless of per occurrence attachment? Usually no - aggregate only erodes after per occurrence attachment met.

4. Best Practice Drafting to Avoid Litigation

1. Define Attachment Explicitly:

"Excess attaches when Ultimate Net Loss exceeds $X, regardless of whether underlying has paid, provided underlying is legally liable. For purposes of attachment, underlying deemed exhausted when liability ascertained by judgment, arbitration award, or settlement approved by excess."

1. Define Order of Erosion:

"Losses shall be applied to tower in chronological order of ascertainment, earliest ascertained first, per Teal v Berkley."

1. State Exhaustion Type:

"Vertical exhaustion applies. Only underlying policies for same policy period need be exhausted."

1. Exclude Improper Erosion:

"Only payments for loss covered under terms of underlying policies shall erode underlying limit."