THE DUTY TO DEFEND IS A MIGHTY OBLIGATION
Membership to a tanning spa required providing a fingerprint scan. However, that was the only requirement made of customers in providing personal information. One customer, upon learning that the spa sold the fingerprint information to a third party, headed up a class action lawsuit. The suit alleged that the sales was in violation of a biometric information privacy law. After the spa filed a claim, its insurer eventually refused to respond to the lawsuit. The insurance company argued that the claim did not qualify as a covered event.
See the court’s opinion on whether the insurer could avoid defending a claim involving how its insured handled personally identifying information.
STATUTES EXCLUSION DOES NOT SUPERSEDE DUTY TO DEFEND
In April 2016, Klaudia Sekura (Sekura) filed a class action complaint against Krishna Schaumburg Tan, Inc (Krishna). Sekura alleged that Krishna violated her rights under the Biometric Information Privacy Act. When becoming a member of Krishna’s, customers are required to scan their fingerprints for identification. In April 2015, when Sekura signed up for a membership, she provided her fingerprint scan. However, she was not provided with written content that allowed Krishna to disclose her biometric data to any other party. Sekura alleged that the violation occurred when her fingerprint data was supplied to an out of state third party vendor without her consent.
West Bend Mutual Insurance Company (West Bend) was the insurer at the time of the suit. It agreed to defend Krishna under a reservation of rights, but then sought a declaration that it has no duties to defend the Sekura lawsuit for three reasons: 1) the alleged action was not covered by the policy since it did not involve advertising or personal injury, 2) it did not qualify for coverage under data compromise, 3) coverage was barred by the policies violation of statutes exclusion. Krishna filed a counterclaim stating that West Bend had a duty to defend the lawsuit and attorney fees. Sekura argued that West Bend was obligated to defend it, was not acting in good faith, and the refusal to defend it was vexatious and unreasonable.
The circuit court denied West Bends’s motion in part and granted Krishna’s motion in part. It found that West Bend had a duty to defend Krishna’s claims and that the claims fell within the policy coverage for personal injury as a “publication,” which violates a person’s right to privacy as well that the exclusion did not preclude coverage. The court declined to reach the issue if the endorsement applied. The court denied Krishna’s motion for summary judgment concerning its request for damages and granted West Bends motion for summary judgment on the counterclaim.
West Bend appealed, and Krishna cross-appealed. According to West Bend, the circuit court erred when it found that it had a duty to defend Krishna’s. West Bend stated that the allegations did not meet the definition of personal injury, and even if allegations contain personal injury, the actions of Krishna violated the statutes exclusion, which bars coverage. Lastly, the data compromise endorsement was inapplicable.
Since the policy did not define publication, the court looked to the common understandings and definitions within the Oxford English Dictionary and Black’s Law Dictionary to determine its meaning. Because a common understanding of “publication” encompasses Krishna’s act of providing Sekura’s fingerprint data to a third party, there also exists potential that the policies cover Sekura’s claim against Krishna. As such, West Bend had a duty to defend Krishna against the underlying complaint about the personal injury coverage provision. As well, the violation of Statutes Exclusion did not apply to bar coverage. The need to reach the data compromise endorsement issue was not needed since the allegations against Krishna fell within the policy.
The appellate court affirmed the circuit court’s judgment and granted summary judgment in favor of Krishna on the duty to defend issue and in favor of West Bend on the on data compromise endorsement.
West Bend Mutual Insurance Co. v. Krishna Schaumburg Tan, Inc., 2020 IL App (1st) 191834
Defending Against Claims Is A Distinct Policy Duty
One might perceive things just like the insurance company mentioned above. You may believe that, once it can be shown that a given loss is ineligible for protection under a given policy, any obligation to handle a claim is terminated. However, often there are questions concerning eligibility and making a clear determination regarding coverage may take time.
The fact that effort is needed to clarify whether protection exists, it has long become established that an insurance company’s duty to provide a legal defense to a policyholder is a separate one. Therefore, an insurer may be considered derelict of its duty if it dismisses a claim without taking time to consider its merits.
Here is an excerpt of wording on supplementary payments found in the ISO Commercial General Liability’s coverage analysis in PF&M.
Supplementary Payments–Coverages A And B
- The following are paid for any claims the insurance company investigates or settles. They are also paid when the insurance company incurs them in order to defend a suit.
None of these costs reduce the limits available to pay for settlements, claims, and judgments.
- All costs the insurance company incurs
- The cost of bail bonds. They are paid only when required because of the use of a vehicle that is covered for bodily injury under this coverage form. The bond must be due to that vehicle having violated a traffic law or because of an accident. The cost is limited to not more than $250. The insurance company is not required to furnish these bonds.
- Cost of bonds to release attachments. However, the cost of only bond limits up to the available limit of insurance are covered. The cost of excess bond amounts is the insured’s responsibility. The insurance company is not required to furnish any bonds.
- Reasonable expenses the insured incurs because the insurance company requests it to assist in the investigation or defense of a claim or suit. When the insured must be away from work, a maximum of $250 per day is paid for loss of earnings.
Note: The expenses must be reasonable and must be incurred based on the insurance company’s request. No expenses are paid for “freelance” investigating or assistance.
- A suit’s court costs that are the insured’s responsibility. These court costs do not include attorney fees or expenses that are taxed by the court against the insured.
Note: This restriction can be very costly to the insured, especially when a court assesses all the proceeding’s costs and expenses against the negligent party.
- If the insurance company pays a judgment, it also pays the prejudgment interest charged against the insured for the amount of the judgment it pays. It does not pay any prejudgment interest that accrues on the part of the judgment for which the insurance company is not responsible. In addition, once the insurance company offers the full limits to settle, it will not pay any prejudgment interest that accrues after that offer.
- Interest that accrues on the full amount (not just the amount within the available limits) of any judgment after it is entered. Once the insurance company pays, offers to pay, or deposits with the court the part of the judgment for which it is responsible no additional interest is paid.
- Under the Contractual Liability exclusion, the cost of the defense of the indemnitee is part of the damages which means that defense costs reduce the amount of limits available to pay for the loss. However, if the insurance and the indemnitee are sued in the same suit and the insurance company defends the insured in that suit, it will also defend the indemnitee and pay under Supplementary Payments if all the following apply:
- The damages the suit seeks must be for liability assumed in the insured contract between the insured and the indemnitee.
- The insurance this coverage form provides must be for the liability described in a. above.
- The insured contract described in a. above must include a provision that requires that the insured assume defense costs or be obligated to defend damages for liability assumed in the insured contract.
- The interests of the insured and the interests of the indemnitees must not conflict with respect to the suit brought. This lack of conflict is based on both the suit’s allegations and the information the insurance company obtains with respect to the suit.
- Both the insured and the indemnitee must ask the insurance company to handle the indemnitee’s defense in the suit and agree to the same legal counsel handling the interests of both parties.
- The indemnitee must agree in writing to actions the insured agrees to do in Section IV–Conditions. This is required because the indemnitee is not a party to the contract and is not subject to those conditions or to even know about them.
The indemnitee must cooperate with the insurance company in investigating, defending, or settling the suit. It must promptly send copies of any demands, notices, summonses, or legal documents it receives related to the suit to the insurance company. The indemnitee must also agree to notify any other insurance company with available coverage and assist all the insurance carriers to work together so that all coverage is coordinated.
The indemnitee must give the insurance company written authorization to obtain records and other information related to the suit. It must also provide written authorization for this insurance company to conduct and control the indemnitee’s defense in the suit.
Attorney fees and all litigation expenses are paid without reducing the limits of insurance when all the above requirements are met.
There is no obligation for the insurance company to defend after the limit of insurance that applies is used up paying judgments or settlements.
In addition, if the indemnitee fails to meet the conditions in f. above, the insurance company is not obligated to pay the indemnitee’s attorney’s fees and other costs of litigation as part of Supplementary Payments.
Taking Time To Investigate Without Triggering a Coverage Obligation
One issue that complicates matters is a real problem for insurers. If an insurer spends significant time investigating a loss for eligibility, that effort lends credence that a loss is legitimate. In order to avoid this danger and to serve a policyholder or claimant, an insurer may investigate a claim with a special stipulation called a Reservation of Rights (ROR).
An ROR is, usually, a separate letter or statement to a party filing a claim that the insurer needs to investigate the circumstances before it can determine whether a loss is eligible for a loss or legal defense. It warns that the steps and time taken to investigate matters does not create an obligation on the insurer’s part since the result of their efforts may be to deny coverage. In other words, while reviewing a claim, the insurer still preserves its legal right to, later, make a denial if it determines that is justified.
Here is an article discussing RORs found in Emarketing section of Advantage Plus.
Reservation of Rights
Although an insurer has an obligation to pay for a loss, it depends upon agreeing that the loss qualifies for coverage. Insurers face a considerable risk. Once it is notified of a claim, an insurer must respond. However, when there is a dispute over a claim, the fact that a company begins to handle a request can, during litigation, be interpreted as admitting a loss is covered. In order to protect itself, an insurance company may use a special document called a Reservation of Rights (ROR) letter.
The ROR may be a form letter or it could be a personal letter to a policyholder. Regardless of its length or amount of personalization, a ROR has a single purpose: to inform that, while the insurance company is active in investigating a loss or is addressing issues related to a lawsuit, it still has not decided about whether the loss or suit is eligible for coverage. Therefore, the fact that it has opened a claim file should not be interpreted as an agreement that coverage exists.
Taking proper time to handle liability claims is particularly important. Policyholders are protected separately by a right to be defended against allegations that they caused injury or damage. Responding to lawsuits requires time to assess circumstances and RORs provide a way to allow assessments without an insurer waiving its rights.
RORs, even when used, still cause confusion with policyholders. However, the alternative is not a good one. A request to handle a loss could be handled very decisively by an insurer immediately issuing a denial or by just automatically agreeing to cover any loss that is submitted. However, being this simplistic is neither fair nor is it good business.
Both policyholders and insurers are served best when all claims are handled in the right manner. ROR letters are a way to make sure that losses are properly evaluated and then a decision is made on whether they qualify for coverage.
COPYRIGHT: Insurance Publishing Plus, Inc., 2018
All rights reserved. Production or distribution, whether in whole or in part, in any form of media or language; and no matter what country, state or territory, is expressly forbidden without written consent of Insurance Publishing Plus, Inc.
What Else Might Impact the Defense Duty
An insurer’s requirement to legally defend a policyholder facing a loss is not unlimited. Situations that block the defense requirement include a policy not being active at the time at a loss because of policy non-payment. Naturally, no obligation exists for a policy that has been cancelled or nonrenewed before the date of a loss. Another reason is when a loss, for various reasons, does not qualify for coverage under a given policy. For instance, one may be sued, legitimately, for violating a professional duty to render a service. However, if the only coverage carried is a Commercial General Liability policy, a loss involving a professional level of service would not be a covered instance.
Note, even when a given loss is eligible for coverage, there’s another circumstance that either bars or ends coverage: the availability of a policy limit to respond. Limit exhaustion can be an important consideration.
Here is an article on whether exhausted policy limits affect the duty to defend. It’s from the March 2019 issue of Rough Notes Magazine.
IF LIMITS ARE EXHAUSTED, MUST INSURER STILL DEFEND?
Know whether your client’s defense costs are inside or outside policy limits
The Court Decisions column is one of the most popular features of Rough Notes magazine. One reason is that the courtroom is where the promises made in an insurance contract often become real. All insurance professionals can develop “what if” scenarios, but until those scenarios are tested with an actual loss and a court decision, they remain mere mental exercises. In this column, the editors of PF&M Analysis, a publication of The Rough Notes Company, will dig a little deeper into one of those court decisions to identify a coverage problem and then provide possible solutions.
This case involved a 16-vehicle accident that occurred after the driver of a semitrailer was unable to stop in time when approaching congested traffic. The driver swerved into another lane, striking a logging truck. Both trucks then struck several other vehicles. With multiple instances of vehicular damage and occupant injury, the driver’s insurance was insufficient to handle the mega-claim.
The insurer, faced with the potential for a huge defense obligation spread among many claims, chose a strategy to end its obligation. It selected a single claimant and paid out the policy’s limits. Per policy language, the exhaustion of limits ended the insurer’s obligation to provide its insured a legal defense.
The duty to defend is at the heart of liability insurance. The provision’s wording is usually along these lines:
- The insurer states that it has a duty (obligation) to another party, in this case the insured.
- The insurer has the right to provide a defense against any lawsuit for damage or injury to others that is covered under the policy.
- Lawsuits against the insured may be investigated and settled if appropriate.
- The insurer will pay interest levied during litigation, taxes, or loss of income suffered by the insured.
- Specific situations may terminate the obligation to defend; these could include a determination that a claim is not covered, payments have been made, or limits have been exhausted.
The insurer’s duty to defend is the first layer of coverage for damages alleged against an insured. When allegations are investigated or disputed, the costs can become substantial.
In personal liability insurance, the cost of defending the insured is outside policy limits. In commercial liability coverage for premises and vehicles, defense costs also typically are outside limits. In specialty or professional liability policies, defense costs are more likely to be inside limits.
It makes sense for agents to educate their personal lines clients about the value of having defense costs paid outside their liability policy limits. With regard to commercial lines clients, it would be prudent to make them aware of the value of their policies’ coverage for defense costs and to guide them in making coverage decisions that take the protection into consideration, regardless of whether it is provided within or outside policy limits.
When coverage is provided outside of limits, insurers frequently consider such limits and the premium they have collected versus what is being expended in handling suits. It may make sense to recommend that your client increase limits. When defense is provided within limits, careful consideration of selected limits is critical. When defense costs reduce available limits, limit adequacy must be an immediate concern. Increased limits and excess coverage may be the path to pursue.
Bruce D. Hicks, CPCU, CLU, is senior editor for Technical and Educational Products at The Rough Notes Company. He has more than 30 years of property/casualty insurance experience, including personal and small business underwriting as well as compliance duties for several national and regional insurers. Active in the CPCU Society, Bruce served as a Governor of the organization from 2007 through 2010 and currently serves on its International Interest Group Committee.