Top Ten Insurer Coverage Decisions

When a policyholder gets sued and notifies a liability insurer, the insurer has ten critical coverage decisions to make. The policyholder may respond to each of these decisions.[1]

No. 1. Should the Insurer Accept Full Coverage? When a plaintiff sues a defendant with a liability insurance policy, the first thing the insurer always does within the Chinese Gong[2] is to determine whether the plaintiff’s claim will be covered by the policy. Often the answer is “Yes”[3]: An adverse judgment will definitely be covered and the insurer will pay it, such as what usually happens with an automobile accident.

No. 2. Should the Insurer Deny All Coverage? Sometimes the answer is “No”[4]: An adverse judgment cannot possibly be covered and the insurer will not pay it nor will the insurer pay for the defense of lawsuit.

No. 3. Should the Insurer Reserve Rights? Increasingly, the answer is “Maybe”[5]: Hmmmm, an adverse judgment may or may not be covered depending on what happens during the defense of the lawsuit and the insurer will pay for the defense of lawsuit. Since the insurer may make this decision at almost any time, no policyholder is truly safe from being abandoned by an insurer.[6] The scope of a reservation of rights often requires clarification.[7]

No. 4. Should the Insurer Hire Dependent Counsel? An insurer that agrees to defend and reserves its rights to deny coverage may decide to hire a lawyer loyal to it to protect its interests and to defend the policyholder as a party to the lawsuit.[8] The decision to hire dependent counsel is distinct from the decision to pay for independent counsel.

No. 5. Should the Insurer Agree to Pay Independent Counsel? An insurer that agrees to defend under a reservation of rights may voluntarily agree to pay for a lawyer selected and directed by the policyholder to defend the liability lawsuit.[9] The frequency[10] and rate[11] that an insurer must pay to dependent counsel to defend the policyholder in the plaintiff’s lawsuit may depend on whether Civil Code §2860 applies[12] and when the insurer starts paying dependent counsel.[13]

No. 6. Should the Insurer Actually Pay Independent Counsel? The fact that an insurer says that it will defend its policyholder under a reservation of rights does not necessarily mean that it will in fact do so.[14] Because an insurer is not licensed to practice law,[15] it can discharge its promise to defend only be paying for a licensed attorney to conduct the defense.[16] An insurer that fails to fulfill its duty to defend may lose it contractual right to control settlement.[17]

No. 7. Should the Insurer Accept a Settlement Offer? When a plaintiff makes an offer to settle the liability lawsuit for an amount within the insurer’s policy limit, the insurer must decide whether or not to accept that offer.[18] The insurer has a duty to attempt to settle in good faith,[19] to negotiate with the plaintiff,[20] and even to initiate those negotiations.[21]

No. 8. Should the Insurer Sue for Declaratory Relief? An insurer that seeks to deny coverage has an option to seek an early determination of whether it has any duty to defend or indemnify its policyholder for a plaintiff’s lawsuit by filing a declaratory relief action while the liability suit is still pending.[22] However, doing so bears risks.[23] A declaratory relief action may be stayed or dismissed[24] if any issue of fact or law is “logically related” to any disputed issue pending in the liability suit.[25] One insurer was found guilty of malicious prosecution for suing.[26]

No. 9. Should the Insurer Seek Reimbursement of Defense Costs? An insurer that reserves its rights to later deny coverage may decide to also reserve its right to later sue its policyholder to recover back its costs of defense that were never even potentially covered by the policy.[27] However, dependent counsel who has failed to obtain the policyholder’s informed written consent to be paid by the insurer may be obligated to disgorge fees.[28] A policyholder may resist such efforts.[29]

No. 10. Should the Insurer Seek Reimbursement of Settlement Costs? An insurer that defends under a reservation of rights may have a duty to accept a settlement offer within policy limits even though it is not covered by its policy.[30] If and when it decides to settle, it may reserve its right to later sue its policyholder to recover back its costs of Will the insurer sue its policyholder to recover back its costs of settlement.[31] A policyholder may resist such efforts.[32]


[15] “No person shall practice law in California unless the person is an active member of the State Bar.” (Bus. & Prof. Code § 6125.)

[16] “By its very nature the duty assumed by [the insurer] to defend its assured against suits must necessarily be classified as a delegable duty, for [the insurer] had no authority to perform that duty itself and, in fact, was prohibited from appearing in the California courts. Since a carrier is not authorized to practice law, it must rely on independent counsel for the conduct of the litigation.” (Merritt v. Reserve Ins. Co. (1973) 34 Cal.App.3d 858, 880-881 (citations and ellipses omitted).)

[19] Ins. Code § 790.03(h)(5) requires in insurer to attempt “in good faith to effectuate prompt, fair, and equitable settlements of claims in which liability has become reasonably clear.” “It is reasonably clear that California courts will interpret the California statute as imposing upon an insurance company the duty actively to investigate and attempt to settle a claim by making, and by accepting, reasonable settlement offers once liability has become reasonably clear.” (Pray v. Foremost Ins. Co. (9th Cir. 1985) 767 F.2d 1329, 1330.)

[20] “[T]he duty to accept reasonable settlements . . . would indeed be meaningless if it did not entail a duty to negotiate toward a reasonable settlement.” (Shade Foods, Inc. v. Innovative Products Sales & Marketing, Inc. (2000) 78 Cal.App.4th 847, 906.) The law “requires that the insurer at the very least must itself consider and determine whether or not a settlement offer is in the best interest of the insured. If in failing to consider, accept, or make a reasonable settlement offer there has been actual bad faith on the part of the insurer, there is an obvious breach of duty to the insured. . . . There is a clear implicit consensus in the cases on this subject that the duty to consider and weigh all the factors bearing upon the advisability of a settlement in the interests of the insured is upon the insurance carrier. Obviously this legal duty is exercised normally in conjunction with the judgment of counsel defending the cases against the insured.” (Garner v. American Mut. Liab. Ins. Co. (1973) 31 Cal.App.3d 843, 848.)

[21] “[A] formal settlement offer [from the plaintiff] is not an absolute prerequisite to a bad faith action in the wake of an excess verdict when the claimant makes a request for policy limits and the insurer refuses to contact the policyholder about the request.” (Boicourt v. Amex Assur. Co. (2000) 78 Cal.App.4th 1390, 1399.)

[22] “Any person interested under a contract, or who desires a declaration of his or her rights or duties with respect to another, may, in cases of actual controversy bring an original action for a declaration of his or her rights and duties, including a determination of any question of construction [of the] contract. The declaration may be had before there has been any breach of the obligation in respect to which said declaration is sought.” (Code Civ. Proc. § 1060 (ellipses omitted).)

[24] “When an insured calls upon a liability insurer to defend a third party action, the insurer as a general rule may not escape the burden of defense by obtaining a declaratory judgment that it has no duty to defend. Were the rule otherwise, the insured would be forced to defend simultaneously against both the insurer’s declaratory relief action and the third party’s liability action. Because the duty to defend turns on the potential for coverage, and because coverage frequently turns on factual issues to be litigated in the third party liability action, litigating the duty to defend in the declaratory relief action may prejudice the insured in the liability action. To prevent this form of prejudice, the insurer’s action for declaratory relief may be either stayed or dismissed.” (Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 302 (Montrose) (Kennard concurring opinion) (citation omitted).)

[25] “[W]hen the coverage question is logically unrelated to the issues of consequence in the underlying case, the declaratory relief action may properly proceed to judgment.” (Montrose, supra, 6 Cal.4th at 302.)

[26] See, George F. Hillenbrand, Inc. v. Insurance Co. of North America (2002) 104 Cal.App.4th 784.

[28] “A [lawyer] shall not accept compensation for representing a [policyholder] from [an insurer] unless . . . The [lawyer] obtains the client’s informed written consent.” (Rule 3-310(F).) See, Practice Pointer: Disgorging Dependent Counsel Defense Fees and Costs.

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