There has been much commentary on the Fifth Circuit decision earlier this month in Citigroup Inc. v. Federal Ins. Co., United States Court of Appeals (5^th Cir. August 5, 2011). Once again in a substantial line of decisions over the past four years, a court has upheld excess policy language providing that the excess insurer has no payment obligation for an otherwise covered Loss unless and until all of the underlying insurance has been exhausted by virtue of actual cash payments by those insurers.

Citigroup in a sense is not only the latest, but perhaps also the most significant, as it is the first decision in this line from a federal appellate court. The victories here by insurers, however, remind me of the insurers’ experiences with the regulatory exclusion in the early 1990s.

After some initial setbacks, the insurers began to win case after case in successfully applying the regulatory exclusion to claims brought by the FDIC and other regulators against failed banks and savings and loans. Nonetheless, once the savings and loan crisis subsided, the regulatory exclusion (which was typically endorsed onto the policy, as opposed to being in the policy form) made only rare appearances. Of course, many insurers probably long for this exclusion now in the face of a new wave of failed bank claims, but that is a story for another post on another day.

Similarly, shortly after the seminal decision in Comerica v. Zurich American Ins. Co., 498 F. Supp. 2d 1019 (E.D. Mich. 2007), brokers labored mightily and successfully to change the “exhaustion language” in excess D&O forms. Their arguments were to the effect that, as long as your attachment point remained unchanged, you were not actually harmed by the insured itself or some other source stepping in to fill any unpaid gaps. A typical provision now reads in pertinent part as follows:

The Insurer shall be liable to pay Loss only after any combination of the Insured, all insurers constituting the Underlying Insurance, and any other source shall have paid the full amount of liability provided by the Underlying Insurance.

Had this language been in place, there is little doubt that Comerica and Citigroup would have been decided differently.

As in most of these cases, the insureds argued for the application of the hoary precedent of Zeig v. Massachusetts Bonding & Ins. Co., 23 F.2d 665 (2d Cir. 1928). Refreshingly, the Citigroup court declined to apply Zeig, finding that the clear and unambiguous language in the policies precluded its application and that there was also no reason that a Texas court applying Texas law would necessarily adopt Zeig.

We may still see other decisions that follow Citigroup because the excess exhaustion language at issue there may also be at issue in other pending and future coverage litigation. However, as time passes, the predominant language will no doubt be similar to the sample language quoted above. In those cases, so long as the loss amounts are covered, the insurers will have an obligation to pay when the insured or other party steps in to fill any “gaps” left unpaid by the underlying insurers.