I’m currently preparing to try another coverage case.  This one involves the question of whether an insurance company, having denied a defense outright, can later second-guess the amount of defense costs and settlement paid by the policyholder out of its own pocket. 

In preparing the case, I came across an interesting opinion written by the sometimes-controversial Judge Richard Posner of the Seventh Circuit, Charter Oak Insurance Company v. Color Converting Industries Company, 45 F.3d 1170 (7th Cir. 1995).  (The case coincidentally involves the same insurance company as in my case.  I won’t bore you with the details, but the issues are slightly different.)   Whatever you may think of Judge Posner, the guy can write.  Here’s how he concisely defines the competing interests of the policyholder and the carrier when it comes to settlement with the underlying plaintiff:

“The principal contractual duty that an insurer’s delay in coming to terms with the insured’s tort victim can violate is the implied duty…to manage the defense of the liability claim in such a fashion as will minimize the risk to the insured of an excess judgment. Because insurance policies have limits, a liability insurance company might prefer to roll the dice and litigate with its insured’s tort victim, knowing that its liability was capped at the policy limit and that if it was lucky and won the case it would not have to pay anything. The insured would prefer the insurance company to pay right up to the policy limit if by doing so it could eliminate the danger of a judgment above that limit, since any difference between the judgment and the policy limit would be payable out of the insured’s own pocket. It is entirely reasonable to suppose that had the parties to the insurance policy thought about this conflict of interest between insurer and insured, they would have agreed that the insurance company was not to exploit it, and was instead to act as if there were no policy limit when it came to decide whether to settle or to litigate.” 

(By the way, I’m not sure that a policyholder would always want the full limits paid out.  That might not be helpful at renewal time, for example, and might also create the impression among the plaintiffs’ bar that the policyholder is an easy mark.  But I do understand the Court’s point.)

As to the ability of a carrier to deny coverage, and later to take the position that the policyholder had made “voluntary payments” and was therefore not entitled to insurance, Judge Posner wrote:

“If the insured does settle and then turns around and seeks reimbursement from the insurance company, it will have to prove that the settlement was reasonable. …[There] are cases in which an insured settled in circumstances where, because the insurance company had not conceded coverage, the insured’s personal assets were at risk. They are analytically similar to cases in which the insurance company’s foot-dragging  places the insured at risk of an excess judgment.”

Posner’s reasoning is similar to that of the New Jersey Supreme Court in Fireman’s Fund Ins. Co. v. Security Ins. Co. of Hartford, 72 N.J. 63, 73 (1976), where the Court wrote:  “If the insurer delays unreasonably in investigating and dealing with a claim asserted against its insured, the insured may make a good faith reasonable settlement and then recover the settlement amount from the insurer, despite the policy provision conditioning recovery against the insurer on the prior entry of a judgment or acquiescence by the insurer in the settlement.”  

Bottom line:  If the insurance company denies or delays coverage, courts say that the policyholder can settle with the underlying plaintiff and, as long as the settlement is reasonable, can successfully claim reimbursement from the insurance company.  The “voluntary payments” provision does not apply.