Responding to an insurer’s declination of coverage

If you are an employer with insurance, but your insurer declines coverage, don’t be discouraged. A disclaimer should not be the end of the coverage dialogue. In fact, there is more you and your lawyer can do to get the insurer to reconsider its decision.

1. Providing additional information

If you’re an insured employer and you find out that your insurer initially declined to provide coverage for a tendered claim, you might panic or be tempted to immediately voice your frustration at the insurer. But read your disclaimer carefully: almost all disclaimers contain language to the effect that the insurer’s position is based on information that is presently known, and it may be subject to change depending on what additional information you transmit to the insurer. This is not just a nice way of saying that the insurers are open to keeping the dialogue going; this is actually a statement of what most jurisdictions require insurers to do. The bottom line is, just because an insurer sent a disclaimer does not mean that all lines of communication have been shut down; you and your attorney should still be alert to any development in litigation or administrative proceedings that may tend to trigger coverage from the available policies.

a. Notice of receipt of disclaimer & retention of lawyer

Your attorney can keep the dialogue with the insurer going by providing it notice that you received the insurer’s disclaimer letter and that you have retained counsel to protect your interests. This lets the insurer know that if its decision to deny coverage is improper, it will be responsible for your reasonable attorney’s fees and other defense costs. Even if the insurer is right in denying your claim, this letter alerts the insurer to the reality that it’s likely that there will be further activity and thus it should keep your file open. Keeping your file open means that the insurer can access it more easily to respond to the addition of new information that might activate insurance coverage.

b. Letter to an excess insurer or primary insurer contesting the disclaimer

When you’ve been denied coverage from an excess insurer, you can contest that position with a letter that you believe that the disclaimer is not well founded, and you will seek policy benefits as well as extra contractual damages. You can transmit a similar letter to primary insurers who have denied you coverage.

c. Letter of notice of a settlement demand against the insured

You or your counsel can also communicate to an insurer that has declined coverage when there is a settlement demand that is made against you, the employer. You can write to the insurer notifying it of the settlement demand, as well as outlining the potential consequences of failing to settle the claim. This can be an occasion to remind the insurer that its failure to provide policy benefits may expose it to extra contractual damages.

If none of these communications succeed in persuading the insurer to change its position on coverage, then you can seek redress by commencing an action against the insurer. Typical claims in these situations include, but are not limited to, breach of contract and breach of the implied covenant of good faith and fair dealing. The implied covenant of good faith and fair dealing is a legal theory that the employer can recover extra contractual damages (that is, amounts beyond what the policy benefits provided for) such as consequential damages, attorneys’ fees for establishing coverage (called Brandt fees in some jurisdictions), and exemplary or punitive damages.

If you seek judicial relief for insurance coverage before any claims against you are resolved, many jurisdictions require that you join the contract and tort claims with a claim for declaratory relief.

2. Involving your broker

You and your attorney should not be shy about asking for assistance from the broker who placed the policy under which the insurer found no available coverage. There are many reasons for involving the broker:

a. The broker may have accidentally omitted coverage that you had requested in the final insurance policy.

During the negotiations between the broker and the underwriter that led to the issuance of the insurance policy, there may have been a discussion about providing coverage for claims that did not appear in the final policy form. Both the broker and insured have the obligation to check each policy after it is issued in order to make sure that the final form reflects the coverage that was requested; however, most insurers readily endorse policies that, through a clerical or drafting error, omit coverages that were intended to be provided.

b. The broker may have relied upon misleading or overbroad promotional materials.

The insurance policy is normally a contract that contains an express integration clause, which is a provision that declares the contract to be the final and complete agreement between the parties, supplanting any other oral or written agreements to the contrary. However, if the broker selected the policy after relying at least in part on misleading or overly broad representations that were in promotional materials, insurers will often have to conform their coverage position so that it’s consistent with the broader coverage that was promised in the promotional material. Often, these promotional materials are distributed to brokers but not the general public. That means that neither you the employer nor your counsel is likely to have access to this material; only your broker does, which necessitates his participation in responding to the insurer’s declination.

c. Brokers can assist you when claims are submitted.

All brokers provide assistance to their insureds when claims are submitted. This is part of their job; they’ve already been compensated for this service when they earned the commission on the policy in question. Most brokers, especially larger ones, have professionals on their staff whose function is to act as claims advocates on behalf of the insured when coverage issues arise. These professionals are familiar with what information must be provided to an insurer in order to trigger insurance coverage. Sometimes, the insurer issues a denial because of the way the underlying claim is described or misdescribed. The claims advocates are also familiar with the policy forms and, because of their experience with similar claims, are likely to be aware of problems with policy language that might not yet be described in the insurer’s reported decisions.

d. Brokers understand the insurance market cycles.

Brokers are sensitive to the cycles in the insurance marketplace. During “hard markets” (when insurance is comparatively more expensive and there is less capacity), claims professionals can enforce the language of the insurance policies with less resistance from the underwriters. When there’s a “soft market” (when insurance is comparatively less expensive, and capacity has expanded either because of new entrants into the market or additional capital is available), underwriters find it harder to obtain and maintain relationships with insureds. As a result, in close cases in a soft market, the broker, working with the underwriter, may be able to persuade a claims professional that a potential for coverage exists where none might be recognized at a different stage in the market cycle.

3. Reminding the insurer of the disadvantages of withdrawing coverage

Comparatively, insurers rarely deny coverage to an insured. Claims professionals are well aware of what can happen if they make an erroneous decision. If there’s litigation, the claims professional and his supervisors will be diverted from their normal responsibilities for days or even weeks. This would take away from their ability to provide services to other insureds.

a. The results of the litigation can mean more liability for the insurer.

Three things can happen when a claims professional denies coverage and there is litigation. The court may find the determination to be: (1) wrong and unreasonable; (2) reasonable but wrong; or (3) correct.

  1. The determination is held to be wrong and unreasonable. If the claims professional makes a wrong decision on coverage, and that decision is found to be unreasonable, he or she has exposed the insurer to additional contractual liabilities beyond just the benefits that were wrongfully withheld from the insured. In extreme cases, this can includes punitive damages against the insurer.
  2. The determination is held to be reasonable but wrong. If the claims professional makes a reasonable but erroneous decision, the insurer will also end up losing more money than if coverage had been provided. The insurer’s ability to control the cost of resolving the claim is also greatly reduced.
  3. The determination is held to be correct. Even if the claims professional made the right decision in denying coverage, there will still be collateral (or secondary) costs for the insurer. Many insureds bring a lawsuit for coverage because they have nothing to lose, and their attorneys usually handle their cases on a contingency fee basis. This is not so for the insurer. Thus, the most cost-effective way for an insurer to resolve the litigation is to make a cost of defense settlement. Because there are high costs associated with bad faith litigation, the cost involved can be substantial. This means that for the insured, he or she ends up with free money—no insurance premium was paid for the benefit received.

In addition, the potential costs to the insurer are raised when there is litigation. You can choose any lawyer you want, which means that the cost of litigating your case can become more expensive. If the insurer ultimately loses the case, it may become responsible for your attorneys’ fees.

b. Litigation means you do not have to abide by the cooperation clause.

Your attorney should communicate to the claims professional the downside of persisting in denying coverage, particularly if the question of whether coverage exists is a close one. If an insurer denies you coverage, it surrenders to you any claims that others may have against you. It also loses the benefit of the cooperation clause in the insurance policy. This means that the insurer can no longer insist that the employer provide information about the progress of the litigation, thus preventing the insurer from developing stronger defenses to coverage based on what is disclosed in litigation.

c. Litigation means the insurer can’t participate in settlement negotiations between you and the employee claimant.

Litigation will also mean that the insurer gives up the right to participate in the settlement process of the claim between you and your employee. Assuming that public policy allows for you to be indemnified by the insurer on your type of claim, the insurer might end up paying more here than it would have paid had it remained in defense of your interests.

If you don’t have the money to defend yourself against the employee claimant, then there will likely be a default judgment against you. That means that ultimately, through indemnification, the insurer will bear the responsibility for paying the full amount of the judgment.

Even if you are capable of defending yourself, if you breach your duty to defend, that often escalates into a breach of the duty to settle. This has ramifications to the insurer because that means the insurer could be exposed to extra contractual liabilities.

d. Litigation means the insurer may lose any right to subrogation.

Additionally, by surrendering the right to be involved in the settlement process, the insurer runs the risk of losing any right to subrogation that might otherwise have existed.

Subrogation is the process by which the insurer steps into the shoes of the insured and asserts the insured’s rights against a legally responsible third party in exchange for the insurer paying out the claim to the insured. The insurer is basically “buying” the lawsuit.

In the employment context, this may involve a legal right against a non-insured party that created the employment practice tort for which the employer was sued. For example, an employer may be held liable for the harassment or discriminatory acts of its clients or vendors on its employees. Settlements and releases that are negotiated without the involvement of the insurer could result in the insurer losing equitable or contractual subrogation rights against the clients or vendors.