United States: Frying Pan Or Fire? Policyholders Beware The Strange Incentives In "Burning Limits" Liability Insurance Policies

We buy liability insurance policies to protect against claims, and the average policyholder expects that their insurance company and the defense counsel they pay for are united in interest to protect the policyholder from loss. One way that this unity of interest has been promoted has been the traditional "defense outside of limits" insurance policy. Under such a traditional standard policy, the insurance company is required to pay defense costs in addition to the full policy limit of the liability policy, which remains 100% available for the payment of judgments or settlements. Thus, even though an extensive and perhaps lengthy defense effort may be needed, the limits available to pay a judgment are not reduced.

By stark contrast, enter the "burning limits" or "wasting" policy whose limits of liability are reduced with each payment of defense-related expense. Defense within limits or burning limits policies have appeared in directors and officers, errors and omissions, employment practices, and some general liability insurance programs. Where they do appear, the nontraditional "wasting" nature of limits creates strange incentives and responsibilities.

For example, assume that an average E&O policy has limits of $750,000, and that an E&O claim costs $400,000 to adequately defend in order to posture the case for resolution favorable to the policyholder. Further, assume that your defense counsel tells you that a favorable resolution is a settlement in the amount of $450,000. The settlement is well within the original limits of the policy. Including the expenditure of defense costs, however, the total loss now exceeds the limit of insurance by $100,000. A burning limits policy leads to insufficient limits available to protect the policyholder in this example.

Defense Outside of Limits Policies Provide More Protection

Policyholders are better protected when defense costs do not erode the limit of liability. Indeed, some courts and statutes have cast doubts on the propriety and public policy implications of burning limits liability insurance policies.

For example, the New York Department of Insurance offers an opinion (Op. No. 08-10-07)* regarding the defense obligation in D&O liability insurance policies, finding that a D&O policy that requires defense within limits violates insurance regulation. The opinion states:

Pursuant to 11 NYCRR § 71.2(a), a liability policy may not contain any provision that limits the availability of legal defense costs (except as otherwise provided for elsewhere in Part 71). That regulatory provision reads as follows:

  1. No liability insurance policy, except as specified in this Part, shall be issued or renewed in this State containing a provision that:

    1. reduces the limits of liability stated in the policy by legal defense costs;
    2. permits legal defense costs to be ap plied against the deductible, if any; or
    3. otherwise limits the availability of coverage for legal defense costs.

Similarly, courts may find that a policy drafted to reduce limits by payment of defense costs violates such a statute. Gibson v. Northfield Ins. Co., 219 W. Va. 40, 631 S.E.2d 598, 2005 W. Va. LEXIS 190 (W. Va. 2005) (citing W. Va. Code 33-6-31(a) to rule that a provision nullifying liability insurance mandated by statute is ineffective); see also Ark. Code Ann. §23-79- 307(5)(A) (requiring an additional separate full limit for defense costs).

Insurance companies under more traditional insurance policies face a potentially significant exposure to defense expenses above the limits of the policy. They thus have a strong financial interest in resolving a matter and limiting their exposure to defense expenses. By contrast, the burning limits policy presents a lower and lower future exposure to expense based on the regular reduction of policy limits by payment of defense costs.

In NIC Ins. Co. v. PJP Consulting, LLC, 2010 U.S. Dist. LEXIS 113207, 2010 WL 4181767 (E.D. Pa. Oct. 22, 2010)(declining jurisdiction on abstention grounds), the insurance company argued that its obligation to indemnify the underlying plaintiff was limited by the insurance policy's $50,000 limit, which had been eroded by defense costs. The insurance company argued that since defense costs already had eroded the limit of liability that it had no further duty to defend or pay indemnity amounts on behalf of the policyholder. The court observed that defense within limits insurance provisions are controversial and might be contrary to Pennsylvania public policy, especially where the limit of liability in the policy is low.

Such a situation suggests that defense expense would easily exhaust policy limits prior to the conclusion of any defense. Statutes, courts and commentators that have reached such conclusions appear to do so to avoid the dilemma of the defense costs being expended to defend the insurance company's interests, leaving the policyholder without limits available to resolve a matter and more properly protect the policyholder.

Plaintiff's Counsel Need Be Aware of Burning Limits

In many ordinary liability claims, the most significant asset available for a plaintiff's recovery is the proceeds of a liability insurance policy. The plaintiff's lawyer who engages in "scorched earth" litigation over an extended period of time may actually leave the client without a viable source of recovery. In this sense, burning limits insurance policies may in certain circumstances encourage plaintiffs and their counsel to resolve matters earlier than they might otherwise. In situations requiring a more extensive defense, however, such a straightforward solution under a burning limits insurance policy is not available.

Defense Counsel Represents the Client as a Whole

Similarly, defense counsel faces an additional concern when defending clients under a burning limits insurance policy. Such a limitation on the expenditure of defense costs puts a premium on ensuring that defense counsel represents the interests of the policyholder. For example, early budgeting and early case assessment is at a premium in a situation where every dollar of defense expense reduces available limits for the payment of a judgment or a settlement. Furthermore, defense counsel should exercise care in responding to inquiries regarding the amount of available liability insurance. Since limits are further depleted with the passage of each month, such information should be considered carefully when responding to inquiries regarding available limits of insurance.

Furthermore, a burning limits insurance policy presents at least the possibility that defense counsel, engaged to represent a policyholder, might be required to continue a defense after the exhaustion of liability insurance limits. In most states, when an attorney seeks to terminate the representation of a client in litigation, that attorney may only do so after taking reasonable steps to avoid foreseeable prejudice to the client. Further, an attorney, after having appeared for a client in court, may only withdraw from such representation in compliance with the applicable rules of such court. These ethical obligations apply regardless of who was paying for defense counsel's services prior to such termination. New York Rules of Professional Conduct Rule 1.16: "Declining or Terminating Representation"; Matter of Kuzmin, 98 A.D.3d 266, 949 N.Y.S.2d 47, 2012 N.Y. App. Div. LEXIS 5631, 2012 NY Slip Op 5708, 2012 WL 3000462 (N.Y. App. Div. 1st Dep't 2012) (lawyer repeatedly failed to formally withdraw from cases as required).

Lower the Heat!

Burning limits insurance policies often provide less protection to policyholders. Even insurance regulators and courts have recognized that the more traditional non-wasting, non-burning limits policies usually provide better protection, and that deviation from such coverage may offend insurance regulations or public policy. Plaintiff's counsel need to be aware of their role in reducing the potential limits available to pay a judgment, and defense counsel must be aware of how burning limits liability insurance policy may impact their ability to protect their client. Armed with an understanding of these dynamics, a policyholder can navigate the strange incentives in burning limits insurance policies.

Footnote

* http://www.dfs.ny.gov/insurance/ogco2008/rg081007.htm

William G. Passannante, co-chair of Anderson Kill's insurance recovery group in New York, is a nationally recognized authority on policyholder insurance recovery in directors and officers liability insurance, errors and omissions insurance, and other insurance disputes including product liability, asbestos, environmental claims, property and food-borne illness. Mr. Passannante's practice focuses on insurance recovery for corporate policyholders and educational and governmental institutions.

About Anderson Kill

Anderson Kill practices law in the areas of Insurance Recovery, Commercial Litigation, Environmental Law, Estates, Trusts and Tax Services, Corporate and Securities, Antitrust, Banking and Lending, Bankruptcy and Restructuring, Real Estate and Construction, Foreign Investment Recovery, Public Law, Government Affairs, Employment and Labor Law, Captive Insurance, Intellectual Property, Corporate Tax, Hospitality, and Health Reform. Recognized nationwide by Chambers USA for Client Service and Commercial Awareness, and best-known for its work in insurance recovery, the firm represents policyholders only in insurance coverage disputes - with no ties to insurance companies and has no conflicts of interest. Clients include Fortune 1000 companies, small and medium-sized businesses, governmental entities, and nonprofits as well as personal estates. Based in New York City, the firm also has offices in Philadelphia, PA, Stamford, CT, Washington, DC, Newark, NJ and Los Angeles, CA.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.