Surprise Ending
The typical person is unlikely to read the full insurance policy covering his or her home or car until some casualty event triggers coverage issues. By then, of course, it’s usually too late to change any key provisions that may inhibit coverage
Lawyers, unfortunately, behave much the same way when it comes to their professional liability coverage. They don’t tend to look closely at their policies until the complaints or demand letters land on their desks.
At that point, one of the biggest surprises for the typical attorney is that the policy gives the insurer the right to select counsel and control the defense of the claim, even though the insured will be the actual client of defense counsel.
Along with that, the attorney will learn that defense costs will in essence be charged against–or “burn off”–coverage limits in the policy. When that happens, less remains to pay off any settlements or judgments on the claim. And if the payout on the claim exceeds what’s left after defense costs have been paid, it will be the insured attorney, not the insurer, who will have to cover the remainder.
The “eroding limits” provision in liability insurance policies can strain the three-way relationship between the insured, the insurer and the defense attorney hired by the insurer to handle the case. It is crucial that all concerned take care to maintain these relationships.
Insurance carriers believe they are able to resolve claims in the most efficient and cost-effective manner by calling on their own expertise to direct defense counsel in whom they repose trust and confidence, and from whom they expect and demand loyalty.
Meanwhile, the insured’s main concern usually is to resolve the claim at or within policy limits as quickly as possible by means of a confidential settlement. And the concern of assigned defense counsel will be to investigate the claim and develop sufficient information to permit the carrier’s claim professionals to reach an informed judgment on whether to settle or continue to defend the claim (without prejudicing the rights and interests of the insured).
Three-Way Split
These potential conflicts can play out in a variety of ways. What if, for instance, plaintiff’s counsel makes a firm “policy limits” settlement demand at the outset of the lawsuit? Defense counsel wants to test the reasonableness of the demand by taking some depositions, but the costs of that discovery will deplete the policy limits below the demand amount. The insured, meanwhile, is anxious to conclude the case and doesn’t want to jeopardize the settlement opportunity.
On the other hand, it may be the insured who insists on pressing the case in court over the recommendations of defense counsel and against the wishes of the carrier.
The first step in resolving these issues must be for all participants in the tripartite relationship–insured, carrier and defense counsel–to be vigilant in identifying the issues, committed to candor and full discussion of the issues as they develop, and mindful of the legitimate competing concerns of all involved.
But that kind of diplomacy doesn’t always work. If, say, the insured does not want to settle the case, the insurer may impose another provision (that the insured may not have read). Under the “hammer clause,” the carrier agrees to let the case proceed with the requirement that, if any eventual payout exceeds a certain amount, the insured will pay for that excess amount, even if it doesn’t reach the policy limit.
Another solution to the eroding-limits dilemma for insureds is to consider purchasing a “defense bank”–an amount that covers defense costs before they are offset against the policy’s coverage limits.
Attorneys should read their liability policies carefully. They may find the contents to be quite interesting.
John H. Riddle chairs the professional and fiduciary liability team at the San Francisco office of Nixon Peabody, where he is a partner. He is a member of the ABA Standing Committee on Lawyers’ Professional Liability.
