As claims professionals know well, insurers have two basic responsibilities to their policyholders. First, an insurer has a broad duty to defend a suit that contains at least one potentially covered claim. Second, an insurer has a narrower obligation to indemnify covered claims. Each duty creates situations in which insurers are obligated to pay costs or settlements for non-covered claims.
In the past decade, two important California Supreme Court decisions have defined liability insurers reimbursement rights for defense costs and settlement payments. Insurer expenditures related to non-covered claims can be recovered under certain, limited circumstances.
In the Buss case, the California Supreme Court determined that insurers are entitled to reimbursement for defense payments towards claims that are not potentially covered, based on the legal theory of restitution. Under that theory, a party who has been unjustly enriched is required to return the unintentional benefit. In other words, when a policyholder does not pay a premium for a particular type of coverage, it is unjust for an insurer to be forced to absorb the attendant defense costs. Those defense costs may be recovered, however, there are three important limiting factors.
First, an insurer must specifically reserve its right to seek reimbursement before it assumes a defense, to give policyholders the option of assuming their own defense. Second, an insurer is only able to successfully seek reimbursement where defense costs are solely attributable to the non-covered claims. Finally, many policyholders lack the financial resources to make a reimbursement action worthwhile. The Buss case is an exception, in that the policyholder, Jerry Buss, is a wealthy sports-entertainment magnate.
Sometimes, a potential claim for reimbursement can arise in “mixed actions.” In a mixed action, one or more claims are potentially covered under the policy, while at least one of the claims is not covered. Public policy dictates that an insurer must provide a complete defense to all of the claims in a suit, even if only one claim is potentially covered. The question then becomes: can an insurance provider that defends a mixed action obtain reimbursement for defense costs allocated to those claims that are not potentially covered under the policy? The answer is yes, but an insurer’s burden of proof is usually difficult.
In reality, it is often difficult to parse out which, if any, defense activities were dedicated entirely to a particular non-covered claim. An insurance provider has the burden of proving, by a preponderance of the evidence, that the defense activities for which it is seeking reimbursement were directed solely at claims that were not potentially covered. For instance, if time is spent doing research that pertains to both covered and non-covered claims, no reimbursement is recoverable. In summary, insurers can obtain reimbursement of defense costs attributable solely to non-covered claims.
The other potential reimbursement scenario arises when an insurance company seeks to recover settlement payments made for non-covered claims. The Blue Ridge case, using the same principles of restitution relied upon in Buss, established the process by which an insurer can reserve its rights for reimbursement.
First, an insurer must put its policyholder on notice that it is reserving its rights to seek reimbursement for settlement amounts attributable to non-covered claims. Second, an insurer must give its insured an opportunity to object to the reasonableness of the settlement amount and to assume its own defense. Most often, an insured will have no choice but to accept an insurer’s decision to settle for the decided amount. If an insured accepts settlement of a case, it may not later claim bad faith for the settlement amount.
As with defense fees, an insurer may recover settlement fees if it can prove that some or all claims are not covered. However, the Blue Ridge court noted that insurance companies bear a substantial risk that their policyholders will not be able to reimburse them. Overall, reimbursement for defense and indemnity costs are available, but only practical in certain situations.
Jeffrey S. Bolender, Attorney
jbolender@bolender-firm.com
Bolender & Associates
Rolling Hills Office Plaza
2601 Airport Drive, Suite 360
Torrance, California 90505
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