Pennsylvania Federal Court Addresses Insolvency Exclusion

In its recent decision ACE Capital Ltd. v. Morgan Waldon Ins. Mgmt., LLC, 2011 U.S. Dist. LEXIS 135902 (W.D. Pa. Nov. 28, 2011), the United States District Court for the Western District of Pennsylvania had occasion to consider the scope of an insolvency exclusion in a professional liability policy.

ACE provided errors and omissions coverage to Morgan Waldon Insurance Management, LLC (“MWIN”), an insurance agency that created and administered employee health benefit plans.  MWIN was named as a defendant in two lawsuits brought by union clients alleging that MWIN had wrongfully created their health care benefit plans as self-insured plans funded by trusts established and controlled by MWIN.  The unions alleged that they did not know that their employers were paying health care benefits into the trust rather than directly to a health care insurer.  The unions claimed that MWIN negligently failed to calculate the monthly contributions necessary to fund the benefits offered, and as a result, the trusts were grossly underfunded and many health care claims subsequently went unpaid. 

Although ACE defended MWIN in the suits, subject to a reservation of rights, it subsequently sought a declaratory judgment on several grounds, including the application of its policy’s insolvency exclusion, which stated that:

We will not defend any Claim or pay any Damages or Claim Expenses based upon, arising out of, directly or indirectly relating to or in any way involving:

*          *          *

3.         Insolvency, bankruptcy, liquidation, receivership, rehabilitation or financial inability of the following, including but not limited to the failure, inability or unwillingness to pay Claims, losses or benefits due to the insolvency, liquidation or bankruptcy of:

    a. Any insurance company; or

    b. Any reinsurer; or

    c. Employee benefit plan; or

    d. Any self-insured program; or

    e. Any trust; or

    f. Any risk retention group; or

                g. Any risk purchasing group.

ACE argued that the exclusion applied because the underlying suits were premised on the theory that the self-insured plans were insufficiently funded, i.e., the plans were insolvent.  MWIN argued that the exclusion was ambiguous as applied, and that its application would defeat MWIN’s reasonable expectations of coverage and would otherwise render coverage under the policy illusory.

The MWIN court acknowledged that in the context of an insurance broker’s professional liability policy, an insolvency exclusion is most often applied in situations in which the broker places a client’s coverage with a carrier that subsequently becomes insolvent.  The court did find, however, a line of cases extending the exclusion to situations in which investment advisors place their clients’ funds in investments that subsequently become insolvent. MWIN argued that these cases were inapplicable since they concerned situations in which third parties became insolvent whereas the underlying suits alleged that MWIN’s own negligence resulted in the insolvency of the plans.  The court held that this was a distinction without a difference, explaining:

… the Policy exclusion is broadly worded: it precludes coverage for any claim "based upon, arising out of, directly or indirectly relating to or in any way involving" the insolvency, bankruptcy, liquidation, receivership, rehabilitation or financial inability of" a number of entities, including an "employee benefit plan," a "self-insured program" or a "trust." … Defendants cannot and do not dispute that the [the underlying suits] allege that the self-insured programs and/or employee benefit plans set up by MWIM to pay the plan members' benefit claims, which were funded through trusts … were unable to satisfy those claims because the plans were insufficiently funded by MWIM. Even if the claims cannot be said to "arise from" the plans' insolvencies, it cannot be argued that the claims do not "relate to" these insolvencies, irrespective of the fact that the mistakes made by MWIM occurred prior to the insolvencies.    

The court further rejected MWIN’s arguments concerning reasonable expectations and illusory coverage.  The court held that as a sophisticated, commercial enterprise, MWIN could not rely on the reasonable expectations doctrine to defeat an otherwise clear and unambiguous exclusion.  Moreover, because the exclusion would only apply to a limited category of claims, the court concluded that the exclusion did not render coverage under the policy illusory.