Never an easy answer for a fraught question
There may be nothing more awkward for an agent or broker
than to find a client being sued by an insurer the producer
recommended to protect the client from lawsuits.
By Joseph S. Harrington, CPCU
There’s a reason we refer to insurance as “risk transfer.” You pay someone else to assume your risk, and don’t expect to owe them anything more other than to comply with policy conditions.
Indeed, a bedrock distinction between insurance and surety is that sureties can seek reimbursement from their principals after paying on a bond. That’s not supposed to happen with insurance, but it does occasionally. There may be nothing more awkward for an agent or broker than to find a client being sued by an insurer the producer recommended to protect the client from lawsuits.
How does this happen? It happens when a liability insurer proffers defense cost coverage for a liability claim under a reservation of rights letter indicating that the claim, still under investigation, may not be covered under the policy.
Liability insurers are expected to provide defense cost coverage for an entire claim, even if only part of it is covered. This duty ends, however, if it is determined, typically by a declaratory judgment of a court, that no aspect of the claim is covered under the policy.
In such cases, insurers have attempted to recoup what they already expended on the insured’s defense, with mixed success.
Explicitly or by law
While many insurers have been rebuffed in their attempts to recoup defense cost expenditures, there are ways some insurers have succeeded in doing so. Two of them rely on legal doctrines whose application varies from jurisdiction to jurisdiction.
Under the doctrine of “implied contract,” an insured that accepts a reservation of rights letter may be judged to have acceded to an indication that the defense cost coverage was conditional and might be revoked. A second doctrine, denying “unjust enrichment,” holds that a party cannot enjoy the benefit of something it has not paid for; in this case, defense coverage for a claim that is not covered at all.
Rather than rely on the vagaries of the law, some insurers take matters into their own hands.
Some insurers will state in their reservation letters that they have the right and intention to seek reimbursement of defense costs if it is determined that no part of the claim is covered. This approach has worked in some cases to overcome the lack of a policy provision authorizing reimbursement, but other courts have rejected it as an attempt by insurers to unilaterally alter the contract without offering consideration to the policyholder.
Supreme contrasts
Eyebrows were raised in 2021 when the Nevada Supreme Court ruled that an insurer could recoup its defense cost expenditures because it had clearly communicated its intent to do so in its reservation of rights letter.[1]
The case was noteworthy because it was one of the first high court rulings on defense cost reimbursement to follow the Restatement of the Law of Liability Insurance, released in 2018 by the American Law Institute (ALI). (Restatements are summaries of the current state of law in certain fields, and provisions of the restatements are commonly cited in court pleadings and rulings.)
One section of the 2018 restatement says that insurers should have no recognized right to reimbursement of defense costs unless it is stated in the policy. The Nevada Supreme Court, in a 4-3 ruling, nonetheless cited precedents in state contract law in holding that there was never an obligation to cover claims found not to be insured under the policy. The three dissenters cited the logic of the 2018 ALI Restatement in claiming that the insurer in this case was essentially seeking to alter the policy contract.
The Nevada ruling was hardly the last word on the matter; few things ever are in the law.
In November 2023, the Hawaii Supreme Court rejected an insurer’s attempt to recoup defense costs. Not only did the policy in that case have no provision for defense cost reimbursement, but the Hawaiian justices held that costs incurred to defend doubtful claims were “part of the deal” in liability insurance. By their very nature, they provided no unjust enrichment to insureds.[2]
Take the defense?
So far, none of these approaches directly involve agents and brokers; they are all triggered after a claim is made. However, two thoughts come to mind.
The first is whether a policyholder, by accepting defense coverage under a reservation of rights by the insurer, is assuming responsibility for expenditures not entirely under its control. We would hope that liability insurance would inspire confidence, not hesitancy (or recklessness), among insureds.
Secondly, producers need to be on the lookout for carriers adding provisions for defense cost recoupment into policy forms. To date, there are few such provisions except in non-standard specialty lines covering management and professional liability. That could change, however, as agents and brokers rely more and more on excess and surplus lines markets using non-filed forms in standard lines.
In short, producers need to alert their clients to the fact that it’s possible their insurers could come back at them.
[1] Nautilus Insurance Co. v. Access Medical, LLC, 482 P.3d 683 (Nev. 2021)
[2] St. Paul Fire & Marine Insurance Company v. Bodell Construction Company, No. SCCQ-22-0000658, 2023 WL 7517083, (Haw. Nov. 14, 2023).
The author
Joseph S. Harrington, CPCU, is an independent business writer specializing in property and casualty insurance coverages and operations. For 21 years, Joe was the communications director for the American Association of Insurance Services (AAIS), a P&C advisory organization. Prior to that, Joe worked in journalism and as a reporter and editor in financial services.
