United States: An Insurer's Excess Of Policy Limits Challenges, Options, And Considerations

Last Updated: August 1 2017
Article by Elise D. Allen

Insurers often face excess of policy limit considerations in three key scenarios:

  1. Does an insurer face excess of policy limits exposure when it has the option to use its limits to settle some (but not all) insureds?
  2. Does an insurer face excess of policy limits exposure when it makes a good faith decision not to settle within limits, but the resulting verdict is above the limits?
  3. Does an insurer face excess of policy limits exposure when it makes a good faith decision not to defend an insured, but the decision is later proven in litigation to have been incorrect?

This article explores these three excess of policy limits situations, problematic jurisdictions, and options insurers should consider in order to guard against excess of policy limits exposure.

  1. Excess of Policy Limits Considerations When There are Multiple Insureds, but the Insurer can only Settle as to One Insured

The recent case of National Surety Corp. v. First Specialty Ins. Corp., No. L-3983-16, 2016 WL 7057503, (N.J. Super. L., Nov. 18, 2016), litigated by BatesCarey, provides an exemplar where the court accepted the insurer's argument that it could use its limits to settle out only one of its two insureds—contrary the objections of the second insured.

In National Surety, the insurer proposed settling claims against one of the insureds for its $2 million policy limits, releasing that one insured from the underlying lawsuit but not extinguishing the claims against its other insureds. The National Surety court ruled that once the insurer exhausted its policy limits in settling the claims against one of its insureds, the insurer's obligations under the policy concluded and the insured's duty to defend all of its insured ends upon exhaustion of its policy by way of settlement with the one insured.

In so ruling, New Jersey adopted the majority rule that where the potential liability facing co-insureds exceeds the available limits of insurance, the insurer is permitted to use its best judgment to effectuate a settlement, even if that means settling out some insureds and not others, without fear of an adverse action. Country Mut. Ins. Co. v. Anderson, 628 N.E.2d 499 (Ill. Ct. App. 1993) (holding that insurers acted in good faith and in the best interest of their insureds when settling out two of the insureds, but not all three). The rationale is that by settling and releasing some of the insureds, the total amount of liability in the underlying action will be decreased, which is a benefit to all of the insureds. Anglo-American Ins. Co. v. Molin, 670 A.2d 194 (Com. Ct. Pa. 1995)(holding that an insurer should not be precluded from accepting a settlement offer for less than all insureds); see also Elliott Co. v. Liberty Mut. Ins. Co., 434 F.Supp.2d 483 (N.D. Ohio 2006) (holding that an insurer can settle or pay claims in good faith to one insured, even if this results in actual exhaustion of the policy limits to the detriment of another insured).

Despite the fact that the majority rule continues to be favorable to insurers, there are still states that prohibit an insurer from settling claims against some, but not all, insureds. See Smoral v. Hanover Ins. Co., 37 A.D.2d 23 (App. Div. 1971) (holding an insurer "cannot prefer one of its insureds over another" with respect to settlement); Lehto v. Allstate Ins. Co., 31 Cal. App.4th 60 (Ct. App. 1994), as modified (Jan. 13, 1995), cert. denied, 516 U.S. 820 (1995) (holding that the auto insurer did not act in bad faith when it refused to accept a settlement offer releasing claims against only one insured, where claims against co-insureds remained pending).

  1. Excess of Policy Limits Considerations When an Insured Makes a Good Faith Decision Not to Settle Within Limits

What if an insurer receives a demand within policy limits, but the defense counsel and common sense both dictate that the settlement value is less the demand? A rationale insurer would likely reject the demand. What then if the verdict ultimately comes in much higher than the policy limit? Can the insurer still be on the risk for judgments in excess of policy limits? In short, maybe, depending on the jurisdiction.

Several jurisdictions adhere to the well-reasoned conclusion that an insurer is not liable in excess of policy limits when it fails to settle a claim, absent evidence of bad faith conduct. See Carford v. Empire Fire & Marine Ins. Co., No. CV065001946, 2012 WL 4040337 (Conn. Super. Ct. Aug. 21, 2012) (finding the insurer did not act in bad faith when it refused to settle the claim within policy limits, and therefore was not liable for any award in excess of those policy limits); Ambassador Ins. Co. v. St. Paul Fire & Marine Ins. Co., 690 P.2d 1022 (N.M. 1984) (holding that in the absence of a finding of bad faith, an insurer cannot be held liable for negligent failure to settle); Smith v. Audubon Ins. Co., 679 So.2d 372 (La. 1996) (holding where an insurer is in control of the defense, absent any bad faith conduct, the insurer is free to settle or litigate at its own discretion without concern of risking liability in excess of policy limits); Olson v. Union Fire Ins. Co., 118 N.W.2d 318 (Neb. 1982) (if the insurer "has exercised good faith in all of its dealings under the policy" then the insurer will not be subject to liability in excess of policy limits).

However, a problematic minority of jurisdictions hold insurers liable for judgments in excess of policy limits where an insurer fails to settle a claim against its insured, even if the insurer did not act in bad faith. Asermely v. Allstate Insurance Co., 728 A.2d 461 (R.I. 1999) (holding that if an insurer fails to settle a case within policy limits, it assumes the risk of miscalculation of judgment, regardless of its good faith belief it has a legitimate defense for coverage, should the judgment exceed policy limits); Andrew v. Century Co., 134 F. Supp.3d 1249 (D. Nev. 2015) (determining that, even though the insurer was found not to have committed bad faith, its wrongful refusal to defend the insured under the policy breached the contract of insurance, and therefore the insurer was responsible for any consequential damages, including those that exceeded policy limits).

The safest course for insurers facing the possibility of an unreasonable and unlikely judgment that may exceed policy limits is to encourage and allow the insured to retain personal counsel at its own expense to monitor this possibility.

  1. Excess of Policy Limits Considerations When an Insured Declines to Defend and Is Later Proven Wrong

The majority rule is that insurers making good faith decisions on the duty to defend are generally shielded from facing risks of liability in excess of policy limits in the event the insurer is later proven to be wrong. See Bannister v. State Farm Mut. Auto Ins. Co., 692 F.3d 1117 (10th Cir. 2012)(key questions as to whether denial was in bad faith denial are whether insured's denial was based on a good faith reason at time of denial and whether insurer conducted a reasonable investigation to determine the validity of the claim); Brockmann v. Board of County Com'rs of County of Shawnee, 404 Fed. Appx. 271 (10th Cir. 2010)(holding that insured's denial of defense could not be characterized as bad faith when insured expressed its willingness to reevaluate upon receipt of additional information, which it ultimately did). Of course, when in doubt, the best protection for an insured is always to file a declaratory judgment action.

Nevertheless, a minority of states indicate that a wrongful failure to defend, even in good faith, could expose an insurer to payment in excess of policy limits. Race City Fasteners, Inc. v. Selective Ins. Co. of S.C., No. 5:05-CV-9-V, 2007 WL 1340404 (W.D.N.C. May 3, 2007), aff'd sub nom. Race City Fasteners, Inc. v. Selective Ins. Co. of S.C., 279 F. Appx. 250 (4th Cir. 2008)(holding that insurer must pay for default judgment entered against insured when insurer declined coverage and rejected insured's argument that even if there is a breach of the duty to defend, such breach does not create more coverage than the insured paid for); Andrew v. Century Sur. Co., 134 F. Supp. 3d 1249 (D. Nev. 2015) ("[t]here is no special rule for insurers that caps their liability at the policy limits for a breach of the duty to defend").

Therefore, it is imperative for an insurer to be cognizant of the majority and minority rules and the problematic jurisdictions when determining whether to settle for less than all insureds, refuse a settlement demand, or elect to deny a duty to defend, even based on a good faith analysis.

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.

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