No reservations: clarity counts in a reservation-of-rights letter.
One of the most critical elements of claim handling is managing the reservation-of-rights (ROR) process. Our subscribers frequently ask whether we think an ROR letter is on point, and, at times, adjusters run their thoughts past us about generating one.
I believe people on both sides of the fence--from adjusters issuing them to agents reviewing them for their clients--understand their importance in the adjustment process. However, sometimes it seems that adjusters are just whipping out their pens (or keyboards) and dashing off letters more as a matter of course than actually trying to present a logical position.
For example, when a third party files a liability claim for damage or injury involving an insured's product or work, adjusters sometimes see the words "product" or "project" and turn to a boilerplate litany of the business risk exclusions. However, merely citing them and then adding that "other exclusions also may apply," isn't quite as valuable to the insured as it should be.
Case law dealing with liability carriers' reservations of rights typically focuses on the overall reasonableness of their actions, not only when issuing original ROR letters, but also during their subsequent behavior in dealing with insureds under those reservations of rights.
The purpose to reserving a liability carrier rights, of course, is twofold: to provide the insurance company with the means to avoid breaching its duty to defend; and to provide the insured an opportunity to assume that very defense. Although jurisdictions may differ on the exact manner, methods, means, and timeframe allowed for providing this notice to insureds, in general, specific reasons for the reservation must be provided in a reasonable amount of time.
While it is wise to include all pertinent reasons for reserving the carrier's rights, an adjuster should be as focused and specific as possible to fulfill the second purpose of the letter--enabling the insured to determine whether it should mount its own defense. As noted in a Washington appeals case, Weber v. Biddle, when a general ROR letter is sent and the carrier maintains control of the defense under that reservation, the carrier owes a high fiduciary duty to the insured. An insurer cannot just issue the letter, safeguard only its own interests during negotiations and litigation, neglect the financial risk to the insured, and then expect to get away with it. Although carriers do not have to itemize every issue that may interfere with coverage, they must be clear on the risks their clients have of there being no coverage.
What Not to Do
Failure to comply may place the insurer squarely on the hook of not only defending but also paying damages on the claim, despite the facts of coverage. Once an ROR is issued, insurance companies continue their investigations and defend the allegations contained therein. Unfortunately, that is where the problems are compounded. A 2007 ruling from the Washington Supreme Court is a good example of exactly how bad things can go. The reasoning in Mutual of Enumclaw Ins. Co. v. Dan Paulson Const., Inc. (DPCI) shows what an insurer should not do when defending an insured under an ROR. The case involved the Martinellis, who contracted with DPCI to build their home. The couple subsequently initiated arbitration proceedings against DPCI, alleging construction defect. DPCI tendered its defense to its liability insurer, Mutual of Enumclaw, which agreed to defend the company under an ROR. The coverage issue involved the exclusion for damage to "your work," with the question arising from how much work had been completed by subcontractors (an exception to the exclusion) and how much had been done by DPCI.
Enumclaw tried to intervene in the arbitration proceedings, or, alternatively, to have an insurance company coverage representative observe. DPCI denied both requests, but the insurer did not ask the arbitrator for permission to attend, as permitted under arbitration rules. Enumclaw did, however, issue a subpoena to the arbitrator, in an effort to schedule a deposition on certain written questions after the arbitration was concluded. The insurer also sent the arbitrator a cover letter explaining the coverage issues it had with the claim. Both DPCI and the Martinellis received the subpoena two days before the arbitration hearing was to start, but neither received the cover letter because it was sent solely (ex parte) to the arbitrator. After all the parties protested the subpoena, Enumclaw sent a second letter to the arbitrator, once again outlining its coverage dispute.
During the sixth day of the hearing, the parties reached a negotiated settlement, which the court subsequently confirmed and converted to a legal judgment.
Both sides then filed actions against one another. After appeal, the Washington Supreme Court eventually reviewed the case. It ruled that the insurer had acted in bad faith through the subpoena and its one-sided communications to the arbitrator. The court stated that, under a reservation-of-rights defense, "the insured receives the defense promised and, if coverage is found not to exist, the insurer will not be obligated to pay." Although an insurer may seek a declaratory judgment on its duty to defend, it must not seek adjudication of factual matters that are under review because such action constitutes bad faith.
In fact, the Washington court continued, that an insurer defending under an ROR has a heightened obligation of fairness toward its client because of the possibility of conflicts of interest between the insurer and its insured that are inherent in such a defense.
The court did not buy the argument that Enumclaw's conduct was merely "somewhat clumsy" or "improper." The fact that the insurer tried to resolve coverage issues immediately prior to and during the arbitration trial "directly interfered in the defense it was providing to DPCI."
The case illustrates that the proper issuance of ROR letters may require extra diligence from the insurer in watching over the risk their insureds face when coverage is questionable. An insurer cannot abandon its fiduciary responsibility when looking after its own interests. As quoted in the ruling on the Paulson case, the insurer controls whether it acts in good faith or bad. The insurer, therefore, must bear the consequences of its conduct.
Be Mindful of Clients' Rights
Judging from the missteps in Mutual of Enumclaw Ins. Co. v. Dan Paulson Const., Inc. (DPCI), insurers can glean many insights about how to appropriately defend an insured under an ROR. The court's ruling in that case emphasized the insurer's heightened duty of fairness toward its client and outlined four criteria for insurers. Acting in good faith necessitates the following:
* Thoroughly investigate claims against insureds.
* Retain competent defense counsel for insureds.
* Fully inform insureds of all developments relevant to coverage and the progress of lawsuits.
* Refrain from engaging in any actions that demonstrate a greater concern for money rather than clients' financial risk.
BY DIANA REITZ, CPCU
Diana Reitz, CPCU, is editorial director for FC&S Online. She may be reached at email@example.com.
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|Title Annotation:||Claim Queue|
|Date:||Dec 1, 2009|
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