Policy limits demands can be a powerful tool for plaintiffs' counsel and can cause headaches for claims handlers. Depending on the circumstances, an insurer that misses an opportunity for a reasonable settlement of a claim against its insured may be liable for the full amount of a later judgment, regardless of the policy limits. Policy limits demands can feel like a set up, and sometimes they are. What factors should claims handlers consider in evaluating them?
Duty to settle
In California, insurers have a duty to settle claims against insureds pursuant to the covenant of good faith and fair dealing implied in all policies. Communale v. Traders & General Ins. Co., 50 Cal.2d 654 (1958). There is an obligation to accept a reasonable settlement within policy limits where there is a "substantial likelihood of a recovery in excess of those limits." Johansen v. California State Auto Inter-Ins. Bureau, 15 Cal.3d 9, 14 (1975). An insurer that wrongfully refuses to settle – that is, an insurer that puts its own interests above the insured's – can be liable for the "entire judgment against the insured even if it exceeds the policy limits." Communale, supra, 50 Cal.2d at 661.
The rule is rooted in conflict of interest principles. A "genuine and immediate" conflict arises between an insurer and its insured when a claimant offers to settle an excess liability exposure for an amount within the policy limit. Merritt v. Reserve Ins. Co., 34 Cal.App.3d 858, 870 (1973). From the insured's perspective, any settlement within limits is in his best interest, since it "will cost him nothing." Id. at 869. But whether a settlement is in the insurer's best interest depends on the "probabilities of winning or losing the suit." Id. at 870. The rationale for the excess judgment rule is that, if the insurer elects to gamble about the value of a case, it does so with its own money.
Johansen involved an insurer's failure to settle an underlying action arising from an auto accident. The insurer "conceded the virtual certainty of a judgment against the [insured] in excess of the policy limits." Johansen, supra, 15 Cal.3d at 13. However, the insurer disputed coverage and refused to settle. The California Supreme Court held the insurer's conduct was wrongful, even though it based its decision on a bona fide belief the policy did not apply.
The Johansen court stated: "? the only permissible consideration in evaluating the reasonableness of the settlement offer becomes whether, in light of the victim's injuries and the probable liability of the insured, the ultimate judgment is likely to exceed the amount of the settlement offer." Id. at 16. Thus, an insurer's determination of whether to accept an offer to settle for, or within, policy limits must be based on an evaluation of liability and damages, not coverage. If the insurer is wrong about coverage, it is generally liable for the damages awarded in the action, even if above the policy limit.
Determining whether a demand is reasonable
Whether to accept a policy limits demand depends on whether the settlement demand is reasonable under the circumstances. "The duty of good faith and fair dealing does not impose a categorical obligation ? to accept a settlement demand regardless of cost." Continental Casualty Co. v. United States Fidelity & Guaranty Co., 516 F.Supp. 384, 389 (N.D. Cal. 1981). The duty of good faith requires an insurer "to settle in an appropriate case." Walbrook Ins. Co., Ltd. v. Liberty Mutual Ins. Co., 5 Cal.App.4th 1445, 1456 (1992) (quoting Communale v. Traders & General Ins. Co., supra, 50 Cal.2d at 659)
An insurer must consider the insured's interests in evaluating a demand within policy limits, but the insurer "need not jettison its own." Merritt, supra, 34 Cal.App.3d at 874. After all, "[i]nsurance companies are businesses, not charities." Walbrook, supra, 5 Cal.App.4th at 1459. Timing of a demand is a factor in determining reasonableness. Id. at 1457-1458 (court's inquiry was limited to "those settlement offers ? presented after [the insurer] became capable of making an informed decision to accept or reject them").
In cases which include both covered and noncovered claims, the reasonableness of a demand may depend only on the value of the covered claims. See, Camelot by the Bay v. Scottsdale Ins. Co., 27 Cal.App.4th 33, 52 (1994). This is because "the insurer does not insure? the entire range of an insured's well-being, outside the scope of and unrelated to the insurance policy, with respect to paying third party claims. It is an insurer, not a guardian angel." Id. Therefore, an insurer need not consider settling an insured's punitive damage exposure in evaluating the reasonableness of a demand within limits.
Whether a settlement offer is reasonable depends on the information the insurer knows at the time of the demand. KPFF, Inc. v. California Union Ins. Co., 56 Cal.App.4th 963, 973 (1997). Reasonableness is usually a question of fact. Hodges v. Standard Accident Ins. Co., 1989 Cal.App.2d 564, 574 (1961); see also, Walbrook, supra, 5 Cal.App.4th at 1457 (where both parties had "colorable positions," issue was one of fact for jury); but see, Samson v. Transamerica Ins. Co., 30 Cal.3d 220, 243 (1981) (reasonableness of insurer's handling was question of law where insurer rejected an offer within policy limits after entry of an excess judgment against the insured). While not conclusive, and although hindsight is not the appropriate test, an excess judgment nevertheless can furnish "an inference that the value of the claim is the equivalent of the amount of the judgment and that acceptance of an offer within those limits was the most reasonable method of dealing with the claim." Crisci v. Security Ins. Co., 66 Cal.2d 425, 431 (1967).
An insurer can reserve rights when settling
Handling policy limits demands can be difficult. The California Supreme Court has acknowledged that potential exposure for failure to settle can create an untenable situation for insurers. Blue Ridge Ins. Co. v. Jacobsen, 25 Cal.4th 489 (2001), involved a dog-mauling injury action in which the insurer raised a significant potential coverage issue. The insured imported champion dogs, and the insurer reserved its rights under a homeowners policy to deny coverage for those business operations. The claimant demanded the policy limit and made no secret that the intent was to "'open up' or 'delimit' the policy" should the insurer fail to accept it. Id. at 494. But the insured refused to permit the insurer to reserve rights on the coverage and reimbursement issues, or to agree the demand was unreasonable which could preclude a later bad faith action.
The California Supreme Court recognized the "resulting Catch-22 would force [the insurer] to indemnify noncovered claims" merely because the insured objected to the reservation of rights. Id. at 502. Thus, the court held that an insurer can reserve its rights to seek reimbursement from the insured for noncovered claims in a reasonable settlement payment by (1) issuing a "timely and express" reservation of rights, (2) expressly notifying the insured of its intent to accept the settlement, and (3) expressly offering the insured an opportunity to assume its own defense when the insurer and insured disagree about whether to accept an offer. Id. This allows an insurer both to preserve its coverage defenses and avoid exposure for wrongful failure to settle.
Action required
One thing is certain: Policy limits demands cannot be ignored. Demands involve risks to both the insurer and the insured, and thus they require careful evaluation. Whether or not to accept a policy limits demand turns on an assessment of the critical facts in the particular claim and an evaluation of the reasonableness of the demand.