Posted on: 6/7/2011
Louis Castoria, Thomas M. Herlihy
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Risk transfer and spreading—the cardinal virtues of insurance in law school public policy discussions—have long supported the notion that a liability insurer that wrongfully rejects a reasonable demand that is within its policy limit should be held responsible for a resulting excess-of-limit judgment entered against its insured. As the familiar argument goes, because the carrier controls the defense, the insured is less able to bear the excess-of-limit loss, and the choice not to settle was (we will assume) the insurer’s, so must be the burden of that choice if it was truly wrongful, not merely “wrong” with benefit of 20/20 hindsight.
The early cases that advanced this argument involved liability policies that afforded unlimited coverage for defense fees and costs, cases such as Comunale v. Traders & General Ins. Co., 50 Cal.2d 654, 659 (1958), and Crisci v. Security Insurance Co. of New Haven, Connecticut, 66 Cal.2d 425, 430 (1967), along with their siblings across the 50 states. Does the same premise hold true in the context of a multi-layered tower of coverage, each policy with a depleting limit of coverage that is reduced by defense fees and costs? When there are multiple claims, the claimants, insureds and defense firms impact the balancing act that claims representatives consider in whether and when to settle a given claim.
In the classic definition, a refusal to settle within the policy limit is “wrongful” (in bad faith) when the insurer fails to take into account the insured’s interest “and give it at least as much consideration as it does to its own interest. “When there is great risk of a recovery beyond the policy limits so that the most reasonable manner of disposing of the claim is a settlement which can be made within those limits, a consideration in good faith of the insured’s interest requires the insurer to settle the claim.” (Comunale, at 659.) This doctrine was expressed differently in Crisci: “the test is whether a prudent insurer without policy limits would have accepted the settlement offer.” (Crisci, at 430.)
The Communale/Crisci test is used still in California, and elaborated upon in California civil jury instruction CACI 2334, with the following Direction for Use: “This instruction should be modified if the insurer did not accept the policy-limits demand because of potential remaining exposure to the insured, such as a contractual indemnity claim or exposure to other claimants.”
Like the Comunale/Crisci test, the above Direction focuses on the insurer’s protection of the insured’s overall interest in avoid “potential remaining exposure.” An insured who faces only one claim that is covered under the applicable insurance policy, and no contractual indemnity claim from another party, has potential remaining exposure (we’ll call it “PRE,” for sake of brevity) from two sources in a modern depleting-limit policy: there is the risk that an adverse judgment could exceed the policy limit, and also the risk that defense fees and costs will reduce the policy limit during the life of the case to the point that a settlement offer that was originally within the limit is no longer so at the time of trial.
Although the premise—giving at least equal weight to the insured’s interests as its own—is a easy one to state, its application is not so simple when multiple claims are covered under the same policy, whether in one lawsuit or several, or when excess coverage is available. Then the insured may have multiple PREs that militate for or against accepting a settlement demand for any given claim. For example:
- Do the excess policies follow form with the primary layer and will the excess carriers accept the defense fees and costs that the primary carrier pays as exhausting its limit?
- Is there a realistic PRE of more claimants coming forward, alleging damages from the same or similar conduct? Would those new claims relate back to the current policy year, or be covered under a renewal or replacement of the current primary policy? In other words, do the insurer and insured have a joint interest in “keeping their powder dry” for foreseeable, though uncertain, new claimants?
- At what point in the process may the value of each claim reasonably be determined? Under a depleting-limits policy there is a trade off between the relative certainty of valuation and the declining war chest with which to fund the defense and to indemnify for an adverse award.
Dealing with such complex and hypothetical scenarios is a daunting task for any claims representative. Early communication and cooperation with the insured’s risk manager or broker and any excess carriers’ claims personnel are important to avoid pitfalls at the inception of such a case. Defense counsel, whether appointed by the carrier or the insured, also plays a critical role by providing early, honest and cost-conscious recommendations as to case value and defense/liability prospects to the insured and, in the majority of states that adopt the tri-partite view of defense counsel’s obligations, the carrier. In a depleting-limit world, defense counsel must view their own fees as a PRE, i.e., an essential part of the risk from which the client is being protected by the insurance policy. At a minimum, this means no pointless and costly expeditions into discovery gamesmanship, case overstaffing and other unproductive efforts, which may cause a mediator to be the first person to “evaluate” the case objectively.
Taking such factors into account, how would a comprehensible jury instruction in a bad faith case be crafted? We do not presume to prescribe an all-purpose formula, but some key elements appear quite evident. The principle that the carrier must give at least as much weight to the insured’s interests as to its own remains the centerpiece, but it doesn’t quite set the table for 12 lay jurors, as the Direction for Use in CACI 2334 acknowledges. Especially under depleting-limit policies, the totality of the circumstances that affect the insured’s aggregate PREs must be included in the mix, and they will vary from case to case.
An outcome determinative or cynical viewpoint might treat those circumstances as irrelevant—“the jury will see an excess verdict and know what to do”—but any fair adjudication in a bad faith case cannot be a rule of automatic liability, or, at the other extreme, wholly subjective. This is especially true when extra-contractual/bad faith exposure presents a risk of punitive damages, because the insurer’s due process rights against an unconstitutional award necessitate a clear standard and a substantively fair award. Claims decisions are based on actual information and evaluations, and though they will, of necessity, be incomplete before the trier of fact weighs in on the debate, they are the objective criteria upon which the jury in a bad faith case must determine the fair outcome.
Whether and when to settle is not the only decision that the claims manager faces. Liability insurers at the working layer are also expected to investigate claims and, if the policy imposes a duty to defend, to defend claims that may be within the policy’s indemnity obligation. (These standards are not expressed uniformly throughout the states.) To make an intelligent, informed decision regarding settlement, and, in some states, in deciding whether to defend, insurers must conduct a reasonable and thorough investigation. In litigated claims, that often means paying defense counsel and incurring the costs of discovery—yet also balancing the duties to investigate and to defend with the need to conserve the policy limit. Thus the balancing act becomes one staged at higher and higher levels, with attendant greater risk.
Assume a $1 million depleting limit primary policy, per claim and in the aggregate, with no excess policy above it, and an insured with three pending claims, all covered, arising from the same series of alleged errors. To facilitate the math, assume no deductible. In a perfect world, one could sketch out the amount of defense fees and costs needed to get to a 75 percent confidence level in evaluating each claim, subtract those defense amounts from the policy limit, and as each evaluation point is reached, one could graph out the effect of settling each claim on the remaining insurance money available to defend and settle the other claims. That would be a tidy way to make claim decisions—too tidy, in fact, to bear much resemblance to the real world of litigation, in which summary judgments that should be granted are not, in which other parties treat civil practice as a sport or crusade rather than a profession, and in which facts that seemed fairly certain at the beginning morph into myths. With one or two more levels of complexity to the fact pattern, such as an excess policy or a likelihood of additional claimants, the tidy graph becomes nearly meaningless.
Conservation of limited policy resources is critical to protect the insured’s interest in defending against PREs that have not yet fully materialized. The duty to defend is broader than, and in many cases more important than, the duty to indemnify, where the insured has a strong legal defense against the entire case. The premise of imposing excess-of-limit liability upon the insurer must be revisited and reinterpreted so as to give jurors instructions that recognize the complex world in which claims decisions are now made. This can mean that one of the elements a jury may have to consider is how the insurer handled the expenditure of defense costs in a depleting-limits policy in light of the assessed PREs. Affording effective representation at efficient rates, with an eye toward fairly questioning invoice entries that seem excessive, may be the way for the insurer to show that the insured received value for the defense dollars spent, in light of the insured’s potential remaining exposures.
Louie Castoria and Tom Herlihy are partners with Wilson Elser Moskowitz Edelman & Dicker LLP, resident in the San Francisco office. The views expressed herein are solely the authors’ and do not necessarily represent those of the firm or its clients.