Disputes Insights #2: Insurance Litigation: What Companies Need to Know About Settling Coverage Disputes - and the 'Exhaustion' Trap.

Companies regularly rely on layered insurance programmes to protect against substantial risks such as business liability, business interruption insurance, product liability, directors and officers liability (D&O), or property damage. These programmes are often structured in layers: a primary layer and one or more excess layers, each backed by different insurers. Collectively, these layers form what is commonly known as the insurance tower.

 A recent decision by the Commercial Court of the Canton of Zurich (HG190216, 12 February 2025) made it clear that an insurance tower offers protection only if the policy is properly worded – it can make the difference between accessing coverage or being left exposed.

How Layered Coverage Works

Each insurance layer in the tower responds to a specific tranche of losses. The primary insurer covers losses up to a certain amount. Only once that layer is fully “exhausted” does coverage from the next excess layer become available. Unsurprisingly, insurers covering the lower (and thus more likely-to-be-triggered) layers tend to charge higher premiums.

 If a company suffers a loss of CHF 35 million, Insurer A would cover the first CHF 10 million, Insurer B the next CHF 10 million, and Insurer C the following CHF 10 million. The remaining CHF 5 million would fall outside the tower and be borne by the insured.

But What Does "Exhaustion" Actually Mean?

 Complexity often arises in determining when a lower layer is considered “exhausted.” That determination directly impacts whether higher layers can be accessed.

 If the primary insurer pays its full CHF 10 million limit, exhaustion is usually undisputed. But what happens if there is a coverage dispute and the insured settles with the primary insurer or if the insured’s claim for coverage is only partially granted – say, for only CHF 7 million? Can the insured then recover from Insurer B for losses exceeding CHF 10 million, even if the remaining CHF 3 million was absorbed by the insured itself?

Recent Case: Zurich Commercial Court on Exhaustion

 A recent decision by the Commercial Court of the Canton of Zurich (Judgment HG190216 of 12 February 2025) tackled this issue. A top-holding company had purchased an errors & omissions (E&O) policy with a CHF 30 million primary layer and a CHF 15 million excess layer (as well as further excess layers). The insured’s claim against the primary insurer was denied, and the insured ultimately bore the entire first part of the loss of CHF 30 million itself. The insured then sought coverage from the excess insurer for losses above that threshold.

 The Commercial Court rejected the claim. Why? Because the excess policy defined “exhaustion” as either (1) full payment, (2) a binding promise of payment, (3) a court order requiring payment, or (4) a settlement with the underlying insurer.

 Since none of these had occurred, the excess insurer’s obligations, as the Commercial Court argued, had never been triggered – even though the insured had borne the full CHF 30 million itself. The fact that the insurer of the excess layer was not worse off economically, because the insured borne the first CHF 30 million of the loss and did not seek coverage for that part of the loss, was irrelevant for the Commercial Court. Instead, the Commercial Court in essence referred to the express wording of the policy.

The Key Takeaways: Think Before Settling and Make Sure Your Policy Wording is Right

 Insurance towers offer substantial protection – but only if structured and worded correctly. The Commercial Court’s decision underscores a vital point: the right to claim from an excess insurer hinges not only on the amount of loss, but also on how the lower layers have been dealt with. In particular, many policies require actual exhaustion – usually through payment of the full limit by the underlying insurer. Therefore, there are two key takeaways:

1. Before ever settling or otherwise terminating an insurance dispute, check the wording of your polices.

2. When negotiating or renewing your insurance programme, pay close attention to how exhaustion is defined. To avoid unintended coverage gaps or surprises in coverage disputes, companies should ensure that the “exhaustion” provisions in their excess policies (or follow-form wordings) are broad enough to reflect commercial realities. Ideally, these provisions should expressly address the following scenarios:

• settlements with lower-layer insurers;

• partial or complete loss of coverage litigation against with lower-layer insurers; and

• situations where the insured itself partially or fully absorbs the loss in the amount of the underlying layer.