Marion Leydier, Mark F. Rosenberg and William D. Torchiana | Sullivan & Cromwell
Insurance claims and coverage
Can a third party bring a direct action against an insurer for coverage?
As a general rule, such direct actions are not permitted in most states absent an unsatisfied judgment against the insured. A few states and US territories, however, generally allow a third party to bring a direct action against a liability insurer before a judgment has been entered against the insured tortfeasor. Louisiana permits a direct action against liability insurers by injured persons (or their survivors or heirs) under a number of circumstances, including when:
- the insured is insolvent;
- citation or other process cannot be made on the insured;
- the cause of action is for damages as a result of an offence between children and their parents or between married persons;
- the insurer is an uninsured motorist carrier; or
- the insured is deceased.
Many states, such as New York, allow a third-party claimant to bring a direct action against an insurer when a judgment against the insured is unsatisfied. New York by statute also allows direct actions in certain situations when an insurer denies coverage of a personal injury or wrongful death claim based on late notice, unless the insurer or the insured has commenced a declaratory judgment action within 60 days of the insurer’s denial of coverage and named the injured person or other claimant as a party to the action. Minnesota, by statute, permits direct actions by the state of Minnesota against an insurer for coverage of environmental response costs related to mixed municipal solid waste disposal facilities that are caused by the insured and covered by the insurer’s policy.
Case law in the US is split as to whether and when a settlement between the policyholder and insurer, pursuant to which the insurer has been released from liability under the policy, can bar a subsequent direct action against the insurer by a third-party claimant.
Late notice of claim
Can an insurer deny coverage based on late notice of claim without demonstrating prejudice?
Whether an insurer can deny coverage based on late notice without a showing of prejudice depends on the language of the policy, the jurisdiction and the type of insurance policy involved. Some states, such as New York in certain instances, require that policies issued in the state contain provisions dealing with whether and to what extent prejudice is required to defeat coverage based on late notice.
With respect to occurrence-based policies, the majority of states do not permit an insurer to deny coverage based on late notice unless the insurer has been prejudiced by the delay. New York, which used to be known for its rule that late notice bars coverage regardless of prejudice, modified its common law rule as to certain types of liability policies issued or delivered in New York by amending section 3420 of the New York Insurance Law, effective 17 January 2009, to prohibit an insurer from denying coverage under certain circumstances owing to late notice absent prejudice to the insurer. The statute also shifts the burden of showing prejudice depending upon the tardiness of the notice.
Courts are much more likely to deny coverage for late notice regardless of prejudice under a ‘claims-made-and-reported’ policy, where notification of a claim within a certain period of time is an express part of the insuring agreement, rather than merely a contractual condition.
Wrongful denial of claim
Is an insurer subject to extra-contractual exposure for wrongful denial of a claim?
Most jurisdictions allow an insured to recover some form of extra-contractual damages if an insurer acts in bad faith in certain circumstances, such as when it wrongfully fails to settle a case within policy limits and that failure results in a judgment against the insured in excess of policy limits, or when it is found to have wrongfully denied a defence or indemnity, and thereby breached its duty of good faith and fair dealing. The standard of conduct as to what constitutes bad faith, however, varies by state, ranging from failure to act reasonably to gross disregard of an insured’s interests to wilful misconduct. In some states, various unlawful claims handling practices are identified by statute, but a number of these statutes permit enforcement only by the state rather than by private action.
Certain states, such as Florida, permit a cause of action for bad faith if the insurer does not take affirmative action to settle a case within policy limits, even absent a settlement demand from the underlying claimant, when liability is clear enough and damages serious enough that an excess judgment is probable.
Depending on the jurisdiction, an insured may be able to recover punitive or consequential damages, or both, when the insurer has acted in bad faith. Some states, however, limit recovery of punitive damages to situations involving egregious conduct directed at the public at large.
Defence of claim
What triggers a liability insurer’s duty to defend a claim?
Because the duty of an insurer to provide a defence is contractual, courts generally look to the wording of the insurance policy to determine whether and to what extent an insurer is obliged to defend a claim.
Where the policy imposes a duty to defend certain claims, a majority of jurisdictions determine the existence of a duty to defend a given claim based upon some form of the ‘four corners’ rule. Under this rule, an insurer’s defence obligation is determined by comparing the allegations of the claimant’s complaint to the policy provisions. If, accepting the complaint’s allegations as true, there is even a single claim that would require the insurer to indemnify the insured in the event of a judgment, an insurer is usually obliged to defend the entire action, although in some jurisdictions the insurer may be able to allocate the defence costs to particular claims if the costs incurred are severable. There may also be a duty to defend against certain claims that, if true, would fall within an exclusion when the insured denies the allegations.
In some jurisdictions, courts will consider extrinsic evidence outside of the four corners of the complaint in determining whether the insurer has a duty to defend. In most of these cases, however, extrinsic evidence of actual facts has been used to impose the duty to defend rather than permit the insurer to defeat it.
For indemnity policies, what triggers the insurer’s payment obligations?
Under an indemnity policy, an insurer’s obligation to provide indemnification for defence costs and other loss is determined by a comparison of the scope of coverage afforded by the policy and the claim submitted for indemnity. If the claim falls within the coverage provided by the policy, the claim will be covered. A complaint may include both covered and uncovered claims, and only covered claims in a complaint are generally subject to indemnity.
Is there a period beyond which a life insurer cannot contest coverage based on misrepresentation in the application?
For life insurance, state statutes generally require a one or two-year contestability period beyond which a life insurer cannot contest coverage based on a misrepresentation in the application, although some jurisdictions permit contestation even after the general contestability period where the misstatement was made with intent to defraud. A contestability period allows an insurer a limited time in which to investigate statements made by the insured in its application to determine whether the statements were truthful. If the misrepresentation is discovered within the contestability period, the life insurer may deny coverage even if the fact misrepresented had nothing to do with the cause of the insured’s death.
Are punitive damages insurable?
Whether and to what extent punitive damages are insurable varies by jurisdiction. In some states, there is no public policy against insurance for punitive damages, and an insurance policy providing coverage for such damages will be enforced in accordance with its terms. Other states, however, have a public policy against insurability of punitive damages, at least when imposed to punish the wrongdoer. Not all ‘punitive’ damages, however, are imposed as punishment, and when they are imposed under a state law that views the damages as compensatory, they may be viewed as insurable, even in a jurisdiction that generally bars coverage for punitive damages. Similarly, punitive damages imposed on account of vicarious liability for the acts of another may be viewed as insurable even by a state that generally bars punitive damages coverage.
There are often significant choice-of-law questions when the public policy of the state in which a punitive damages judgment has been rendered differs from the public policy of the jurisdiction whose law governs the insurance policy. In such a situation, the decision may depend on the forum in which the public policy issue is determined. Some policies (especially certain directors’ and officers’ liability (D&O) policies) include a clause providing that insurability for punitive damages will be governed by the law of the jurisdiction that is the most favourable to the insured, so long as that jurisdiction has one of several specified relationships with the parties or the underlying claim against the insured. In some other policies, coverage disputes are resolved by arbitration, and the arbitrator is contractually directed to enforce coverage for punitive damages regardless of the law that might otherwise apply to the policy.
Excess insurer obligations
What is the obligation of an excess insurer to ‘drop down and defend’, and pay a claim, if the primary insurer is insolvent or its coverage is otherwise unavailable without full exhaustion of primary limits?
Whether an excess insurer is obliged to ‘drop down’ is generally a matter of contract. Courts usually look to the policy wording to determine whether and when an excess insurer is required to drop down.
There is a distinction between compelling an insurer to ‘drop down’ so that it assumes the obligations of an underlying insurer when the limits of the underlying insurance have been paid by no one, and requiring the excess insurer to provide coverage when the insured, rather than the underlying insurer, has paid some or all of the amount of the underlying policy limit. In the latter situation – particularly if the excess policy merely requires exhaustion of the underlying insurer’s limits, without expressly requiring that such exhaustion be through full payment of limits by the underlying insurer – some courts refuse to excuse the excess insurer from its obligations. Sometimes this is because the courts, reluctant to provide the excess insurer with what the courts view as a windfall, construe the term ‘exhaustion’ to include cessation of the underlying insurer’s liability rather than full payment of its limits. Such courts often enunciate a public policy rationale, noting that if the entire underlying limit has been paid by someone, the excess insurer has not been prejudiced. Similarly, where failure of the underlying insurer to pay the full amount of its limits is because of a settlement between that insurer and the insured, some courts reason that to permit the excess insurer to avoid coverage because of the settlement would defeat the public policy in favour of settlement. Many courts, however, will enforce the literal terms of an excess policy that require, as a condition of coverage, exhaustion of the underlying policy by full payment of limits by the underlying insurer.
What is an insurer’s obligation if the policy provides that the insured has a self-insured retention or deductible and is insolvent and unable to pay it?
Whether an insurer remains obliged to pay under a contract of insurance when the insured is incapable of satisfying a self-insured retention (SIR) owing to its insolvency varies by jurisdiction. There are two general schools of thought. The public policy approach provides that an insurer is responsible for the amount of covered loss in excess of the SIR notwithstanding that the SIR has not been paid. The strict contract interpretation approach construes the insurance contract strictly and finds that an insurer’s obligations under a policy with an SIR are not triggered until the insolvent insured has paid the SIR. Neither of these schools of thought requires an insurer to drop down and pay the SIR for the insured in the event of the insured’s bankruptcy or insolvency.
Some states that follow the public policy approach have enacted legislation requiring liability policies to include a provision that the insured’s bankruptcy will not relieve the insurer of its obligations under the policy. In those states, even if a policy expressly makes the payment of an SIR a condition precedent to coverage, the obligation of the insurer to pay covered amounts in excess of the SIR amount remains despite the insured’s inability to satisfy the SIR. States that follow the strict contract interpretation approach rely on the law of contracts and treat payment of the SIR as a strict condition of coverage even if the insured is insolvent.
If the insured’s policy contains a deductible amount that is included within the limits of a policy, rather than an SIR over which the policy limits apply, the inability of the insured to pay the deductible generally does not relieve the insurer from its obligation to pay covered claims and expenses. In general, the insurer would have the duty to pay without regard to the payment of the deductible by the insured and, in turn, would have to seek reimbursement for the amount of the deductible from the insured. In such cases, the insurer is generally considered a creditor of the insured with respect to the amount of the deductible paid on the insured’s behalf.
What is the order of priority for payment when there are multiple claims under the same policy?
Certain types of policies contain provisions setting forth the priority of payments when there are multiple claims under the same policy or claims against multiple insureds. For example, D&O policies often include provisions indicating that the individual insured’s claims should be paid first, before the insured organisation is paid. If not specified in the policy, jurisdictions look at different factors in determining priority of payment. Such factors include potential liability, excess exposure and ripeness for settlement.
Some courts have allowed an insurer, when faced with multiple claims against one insured, to exhaust its policy limits in settling one claim, even if that leaves another claim unsettled, where the settlement is reasonable. However, where there are multiple insureds under one policy, some jurisdictions have held insurers to be in violation of their duty of good faith if the settlement of one claim against one insured favours one insured over another. Many jurisdictions have not ruled on the specific issue of whether an insurer can enter into a settlement benefiting one insured to the detriment of others. In a number of instances, insurers facing uncertainty as to how a settlement on behalf of fewer than all insureds will be viewed have commenced interpleader actions, seeking a judicial determination of how the policy limits should be distributed.
Allocation of payment
How are payments allocated among multiple policies triggered by the same claim?
Case law concerning allocation of coverage for a claim that triggers multiple policies in various years is complex and conflicting. A number of different theories have evolved with respect to policies that contain standardised terms that do not deal specifically with the allocation issue. Many of these theories were developed in connection with asbestos insurance coverage cases, and then were subsequently used in pollution coverage cases, which many courts view as analogous.
While there are variations, the following theories are ones generally relied on by the courts:
- the ‘exposure’ theory: under this theory, the policies in effect at the time of the exposure to the hazardous substances are triggered. In personal injury product liability cases, the exposure period is the time during which the underlying claimant was exposed to the product. In pollution cases, the exposure period is the time during which hazardous substances were released or deposited at the site;
- the ‘manifestation’ theory: under this theory, the policies in effect at the time that the injury or damage becomes manifest provide coverage;
- the ‘continuous trigger’ or ‘triple trigger’ theory: under this theory, the injury or damage is viewed as a continuous injurious process, so that all policies from initial exposure through manifestation are triggered; and
- the ‘injury in fact’ theory: under this theory, a policy is triggered if injury in fact occurred during the policy period, even if the injury was, in and of itself, not compensable.
Where multiple years of coverage are involved, courts have split on:
- whether stacking of triggered policies is permitted;
- whether a triggered policy is responsible up to policy limits for all sums owed to the underlying claimant or merely a pro rata share of the liability;
- how and when excess coverage in a given year applies when fewer than all of the primary policies in triggered years have been exhausted; and
- whether and to what extent an insured must bear responsibility for uninsured periods that would otherwise be triggered had appropriate coverage been obtained.
Disgorgement or restitution
Are disgorgement or restitution claims insurable losses?
Courts disagree on whether and to what extent disgorgement or restitution claims are insurable. A decision of the United States Court of Appeals for the Seventh Circuit, which has been followed by a number of courts, held that a settlement of such claims was uninsurable as a matter of public policy, even though there had been no adjudication of wrongdoing. Other courts, however, have found that public policy does not bar coverage at least for defence and settlement of restitution or disgorgement claims, and that any public policy concerns are satisfactorily addressed by the standard conduct exclusion in insurance policies.
Because of the concern that uninsurability of disgorgement or restitution could deprive insureds of coverage for various US securities claims, thereby making D&O policies less marketable, many D&O policies now contain a provision whereby the insurer agrees not to contend that claims under sections 11 and 12 of the Securities Act of 1933 – and sometimes other securities laws provisions as well – are uninsurable.
Definition of occurrence
How do courts determine whether a single event resulting in multiple injuries or claims constitutes more than one occurrence under an insurance policy?
The manner in which the policy defines ‘occurrence’ can be determinative of whether a single event resulting in multiple injuries or claims will be considered one or multiple occurrences. In the absence of explicit policy language addressing the question, some courts have adopted a ‘cause’ test, while others have adopted an ‘unfortunate event’ test. Under the cause test, if there is a single cause of the injuries and claims, that cause will generally be viewed as constituting the occurrence. Under the unfortunate event test, however, which is applied in New York, each of the individual injuries or claims may be considered an unfortunate event that is itself a separate occurrence.
Rescission based on misstatements
Under what circumstances can misstatements in the application be the basis for rescission?
For an insurer to rescind a policy based on misstatements in the application, courts generally require, at a minimum, that there be a material misstatement in the application upon which the insurer relied in issuing the policy. In some states, an intent to defraud the insurer is also required. Ordinarily, a misrepresentation is considered material if the insurer would not, had it received accurate information, have provided the coverage at issue for the premium charged. It is ordinarily not required that the insurer show it would not have issued any policy at all.
Fidelity insurance applications, however, are often treated differently for rescission purposes than other types of coverage. This is because one of the purposes of fidelity insurance is to provide coverage for employee thefts or other losses caused by employee dishonesty that took place prior to the issuance of the policy but are discovered during the policy period. If the dishonest employee’s knowledge were imputed to the insured, the purpose of the coverage would be defeated. Thus, a failure to disclose in the application thefts known only to the dishonest employee or employees will generally not be considered a misrepresentation in the application. If, however, the dishonest employee is the person who actually signs the application, some courts will permit rescission, although other courts will not.
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