Few issues carry as much potential for catastrophic financial surprises as the bankruptcy or insolvency of either the insured or — more commonly and insidiously — one or more underlying insurers in an umbrella or excess liability program. As we move through the first quarter of 2026, this long-standing vulnerability has taken on renewed urgency. Persistent inflation in jury verdicts, rising defense costs, and a series of high-profile insurer financial dislocations have once again cast sunlight on the adequacy (or inadequacy) of policy language designed to address insolvency scenarios.

The Core Policy Provisions and Their Evolution

Every umbrella and excess liability policy contains some form of "Bankruptcy," "Maintenance of Underlying Insurance," or "Other Insurance" condition that attempt to define the carrier's obligations if the insured or an underlying insurer becomes bankrupt or insolvent. Standard language in older forms, simply stated: "Bankruptcy or insolvency of the insured or the insured's estate shall not relieve us of any obligations under this policy."

While such provision protected the insured's estate in the event of its own bankruptcy (as required by law in most all states), it left critical ambiguity regarding self-insured retentions (SIRs) and the obligations of insolvent underlying insurer(s). Does the umbrella "drop down" to fill the gap left by an insolvent primary or excess layer? Or does it only respond excess of the full underlying limits as originally contemplated?
Drop-down refers to a situation in which an umbrella or excess policy is required to begin paying claims at a lower attachment point than originally intended, effectively stepping into the shoes of a failed underlying insurer. Post-1986 ISO CGL revisions prompted many umbrella underwriters to add protective language. A representative provision reads: "This insurance shall not replace any underlying insurance, when such insurance is not available due to bankruptcy or insolvency of an underlying insurer or Insured."

More explicit modern forms, go further: "For all purposes of this policy, if any 'Underlying Insurance' is not available or collectible because of: 1. the bankruptcy or insolvency of the underlying insurer(s) providing such 'Underlying Insurance'; or 2. the inability or failure for any other reason of such underlying insurer(s) to comply with any of the obligations of its policy, then this policy shall apply as if 'Underlying Insurance' were available and collectible."

Other commercial umbrella policies similarly emphasize in their Maintenance of Underlying Insurance condition that collectability of scheduled underlying limits "must be available regardless of the bankruptcy or insolvency of the Underlying Insurers."

The intent is clear: umbrella and excess coverage is priced on the assumption that the layers below it will perform as represented. Carriers have no desire — and often no actuarial basis — to assume the obligations of a failed underlying insurer.

Court Interpretations: A Mixed but Improving Landscape

Despite clearer policy language since the late 1980s, disputes continue. Following the wave of insurer insolvencies in the 1980s, numerous courts initially forced umbrella carriers to "drop down" based on ambiguous wording that failed to explicitly state coverage applied only excess of collectible underlying limits.

A landmark ruling that helped shift the tide came in Louisiana Insurance Guaranty Association v. Interstate Fire & Casualty Company (630 So. 2d 759, La. 1994). The Louisiana Supreme Court held that, due to the very nature of excess insurance, no insured could expect an umbrella carrier to drop down and assume the obligations of an insolvent underlying insurer. The court ruled that policy wording was secondary to the fundamental structure of excess coverage — it sits above, not in place of the underlying limits promised at inception.

Many other jurisdictions have followed this reasoning in the decades since. However, as recently as 2023-2025, several federal and state courts have still found in favor of insureds where policy language was deemed insufficiently clear, particularly in long-tail claims involving continuous or progressive injury.

In 2025, a significant California federal court decision involving a major construction defect highlighted ongoing risks. When a primary carrier became insolvent mid-claim, the excess carrier argued its policy only responded above the full scheduled limits. The insured countered with older policy wording that lacked explicit "non-drop-down" language. The court sided with the excess carrier but only after expensive litigation and a partial settlement — a reminder that even "strong" language can lead to costly disputes if not uniformly applied across all layers.

Emerging Issues in 2026

Several developments are making insolvency-related issues more pressing this year:

  1. Rising Insurer Financial Stress, the combination of elevated catastrophe losses, persistent social inflation, and higher interest rates have strained smaller and mid-tier liability carriers. AM Best and S&P have downgraded several regional insurers in late 2025, raising concerns about potential impairments continuing into 2026-2027. Umbrella underwriters are now routinely requiring insureds to submit current financial ratings for all underlying carriers as a condition of binding.
  2. Guaranty Fund Limitations Insurance guaranty funds (also called guaranty associations) are state-created entities that provide a limited safety net for policyholders when an admitted insurance company becomes insolvent. However, these funds typically cap recovery (frequently at $300,000–$500,000 per claim, sometimes less for commercial lines) and may exclude certain coverages entirely. In multi-state exposures, conflicting guaranty fund rules can create massive gaps. Recent claims involving sexual abuse, opioid-related liabilities, and environmental exposures have exposed these shortcomings dramatically.
  3. Continuous Trigger and Allocation Disputes In long-tail claims — claims where injury or damage develops gradually over many years (such as asbestos, environmental contamination, construction defects, or product liability) multiple policy periods may be implicated. If any insurer from prior years is insolvent, current umbrella carriers face arguments that they must "drop down" for defense costs or indemnity in allocated shares. Ambiguous "other insurance" clauses exacerbate these fights. A 2025 New York appellate decision in a construction defect matter required an excess carrier to fund defense after an earlier primary's insolvency, citing the policy's failure to explicitly exclude such obligations.
  4. Self-Insured Retention Complications A self-insured retention (SIR) is the amount of loss an insured must pay before the insurer's obligation to pay begins (similar to a deductible, but the insured typically handles claims within the SIR without insurer involvement until the retention is exhausted). When an insured declares bankruptcy, questions arise whether the umbrella must drop down below the SIR. Many policies remain silent on this point, creating uncertainty. In a 2024 Delaware bankruptcy court ruling involving a retail chain, the court held that the umbrella did not have to erode the SIR, but the decision turned on specific wording. Insureds in bankruptcy are increasingly using this ambiguity as leverage in negotiations with excess carriers.

Practical Strategies for Avoiding Problems in Layering Coverage

To minimize insolvency-related exposures in 2026, risk managers and brokers should focus on the following:

  • Conduct Rigorous Carrier Due Diligence. Do not rely solely on broker spreadsheets. Obtain current AM Best, S&P, and Moody's ratings for every insurer. Consider requiring minimum rating thresholds (e.g., A- or better) in your insurance specifications. AM Best, S&P, and Moody's are the primary independent rating agencies that evaluate insurers' financial strength and claims-paying ability.
  • Harmonize Policy Language Across the Program. Ensure every layer — primary through high excess — contains consistent, explicit non-drop-down and maintenance of underlying insurance wording. Misalignment between layers is a frequent source of litigation.
  • Negotiate Stronger Bankruptcy/Insolvency Provisions Where possible, push for language that clearly states the umbrella/excess policy applies only excess of the full limits of underlying insurance "whether or not such insurance is collectible." Also seek explicit exclusion from any obligation to assume an insolvent underlying insurer's defense costs.
  • Consider Quota Share and Structured Alternatives. A quota share arrangement is a type of proportional reinsurance or insurance arrangement in which the insurer and insured (or multiple insurers) share premiums and losses at a fixed percentage. In hard markets, some insureds are turning to quota share arrangements on lower layers to reduce reliance on any single carrier. While this can spread risk, it introduces complexity in claims handling and potential disputes over allocation if one quota share participant fails. Clear participation agreements and joint loss agreements are essential.
  • Evaluate Captive or Alternative Risk Transfer Options. A captive insurance company is an insurance entity created and owned by the parent company to insure its own risks (or those of its affiliates). For sophisticated buyers, fronted programs or captives can provide greater control over underlying security. However, regulators and excess carriers will still scrutinize the financial strength of any captive reinsurer.
  • Monitor and Update Schedules. Treat the Schedule of Underlying Insurance as a legal document, which it is! Any change in underlying insurers or limits must be promptly endorsed to the umbrella/excess policies.

Expected Regulatory and Market Changes

State insurance regulators are looking at this area closely. In 2025, the NAIC began reviewing model language for guaranty fund coverage of commercial excess lines, with recommendations expected by late 2026. Several states (including California and New York) are considering legislation that would clarify drop-down obligations in long-tail claims.

On the insurance company side, expect continued tightening of underwriting standards. Many major umbrella writers have already implemented "tower stability" questionnaires that require detailed information on all underlying carriers' financials and claims histories. Premium credits for towers with uniformly strong security are becoming more common, while surcharges or declinations are rising for programs with weaker links.

Conclusion: Vigilance Is Essential

The bankruptcy or insolvency of any participant in a liability insurance tower remains one of the most disruptive events an insured can face. While policy language has improved significantly since the 1980s, ambiguities persist — particularly around defense costs, SIR erosion, and long-tail allocation. In today's environment of social inflation, nuclear verdicts, and selective insurer stress, these issues are no longer theoretical.
Risk professionals who treat carrier financial strength as equally important as limits and retentions will be best positioned to avoid painful gaps. Thorough due diligence, harmonized policy wording, and proactive negotiation of insolvency provisions are not optional — they are essential risk management practices in 2026 and beyond.

By addressing these challenges head-on when placing or renewing umbrella and excess coverage, organizations can significantly reduce the likelihood of finding themselves in expensive litigation or, worse, bearing uncovered losses when a carrier in the tower fails.