Lifelines in the Storm: Pro-Policyholder Developments in 2008

In light of the enormous losses and failures triggered by the financial crisis, companies across the full spectrum of U.S. industry will be looking to their insurance policies for loss mitigation. Fortunately, developments in several states bolstered policyholders’ ability to defeat insurers’ overbroad interpretation of various coverage defenses. State courts and legislatures limited insurers’ ability to deny coverage on late notice grounds; affirmed policyholders’ right to consequential damages when an insurer’s failure to fulfill its contractual obligations causes the death of a company; affirmed the right to coverage for punitive damages under some circumstances; and strengthened policyholders’ hand in settlement negotiations conducted when the defendant’s insurer has reserved its rights.

New York bolstered policyholders’ rights on three fronts in 2008. The first was the decision in Bi-Economy Market Inc. v. Harleysville Insurance Company of New York, et al. that allowed policyholders in New York to recover consequential damages from their insurance company, a right long enjoyed by policyholders in other jurisdictions. In Bi-Economy, the state’s Court of Appeals held that “it is well settled that in breach of contract actions ‘the nonbreaching party may recover general damages which are the natural and probable consequence of the breach'” and that “when an insured … suffers additional damages as a result of an insurer’s excessive delay or improper denial, the insurance company should stand liable for these damages.”

In Elacqua v. Physicians’ Insurers, the court ruled that an insurer’s failure to advise a policyholder of a right to independent counsel violated New York’s deceptive business acts and practices law.

Finally, New York Governor Paterson signed a bill to relax — in certain circumstances — strict rules that allowed insurance companies to avoid coverage when notice of a claim or occurrence is late, even if the insurer was not prejudiced by the delay. New York has joined the majority of states in imposing a prejudice standard for late notice denials when the statute applies.

Other states had significant Supreme Court decisions regarding insurance issues.

In January, the Texas Supreme Court rejected the rule that prejudice is irrelevant to late notice and held that “an insured’s failure to timely notify its insurer of a claim or suit does not defeat coverage if the insurer was not prejudiced by delay.” PAJ Inc. v. The Hanover Insurance Co. The Texas Supreme Court also ruled in Fairfield Ins. Co. v. Stephens Martin Paving, LP, that Texas public policy does not bar insurance coverage for punitive damages under some types of workers’ compensation and employer’s liability insurance. The Court found that while the Texas Legislature made the policy decision to prohibit coverage of exemplary damages in certain limited circumstances, it made no such policy decision in the context of workers’ compensation. Indeed, the Texas Supreme Court found that the Legislature’s expressed intent is that coverage would exist for exemplary damages in the workers’ compensation context. Also, the Texas Supreme Court held that an insurer does not have a right to seek reimbursement for settlement of a claim that is later held not to be covered unless the policyholder expressly agreed to the settlement and to the insurer’s right to seek reimbursement. Excess Underwriters at Lloyd’s, London, et al. v. Frank’s Casing Crew & Rental Tools Inc.

Maine’s highest court issued an important decision on insurance company efforts to rescind policies based on alleged misrepresentation in the policy application. To succeed in such an effort, the Court ruled, in Liberty Ins. Underwriters, Inc. v. Estate of Faulkner, that an insurer must prove fraud, including the elements of materiality and actual reliance on the misrepresentation by the insurance company. On the other hand, the insurer can rescind even if the material misrepresentation was made in an earlier policy application for which the current policy was a renewal. Even if the renewal application did not include the misrepresentation, the insurer can be entitled to rescission.

In Washington, the court in Mutual of Enumclaw Insurance Co. v. T&G Construction Inc. and Villas at Harbour Pointe Owners Association, ruled that an insurer is bound by the factual findings made as part of a reasonable settlement of an underlying liability claim when a coverage determination depends upon those same facts. The Washington Supreme Court determined that a good faith settlement between the policyholder and an underlying claimant establishes the policyholder’s damages for insurance purposes. The Court had previously ruled that this rule applied if the insurer acted in bad faith. In this case, the Court clarified that this rule applies even where the insurer had not acted in bad faith, and noted several other state courts agreed.

These developments strengthened policyholders’ hand in negotiations to settle suits against them, in their resistance to insurer defenses against coverage, and in their recourse in the event of insurer bad faith. In difficult economic times, every boost to policyholder rights can prove to be a lifeline.