In a published case decided under Pennsylvania law, the U.S. Court of Appeals for the Third Circuit held that punitive damages awarded against an insured in an underlying personal injury suit are not an item of compensable damages recoverable in a subsequent coverage action against the insurer.

In Wolfe v. Allstate Prop. & Cas. Ins. Co., 2015 U.S. App. LEXIS 9876 (3d Cir. June 12, 2015), a jury in the underlying state court personal injury action had found the insured liable for personal injuries totaling $15,000 in compensatory damages and $50,000 in punitive damages. The insurer paid the compensatory damages, but refused to pay the $50,000 of punitive damages. In return for the underlying plaintiff’s agreement not to pursue the insured personally, the insured assigned to the underlying plaintiff his rights to pursue the insurer for the punitive damages.

The underlying plaintiff, sitting in the shoes of the insured, then sued the insurer in state court (which was removed to the federal district court) for coverage under the policy, interest, punitive damages and attorneys fees, asserting claims for bad faith and breach of contract. The insurer moved for summary judgment, which was denied, and over the insurer’s objection, the trial court allowed evidence at trial of the punitive damages that had been awarded in the underlying state court action as an element of damages in the coverage action. The federal court jury found the insurer liable for breach of contract and bad faith, awarding the $50,000 in punitive damages.

In a decision predicting what the Pennsylvania Supreme Court would hold, the Third Circuit reversed, ruling that the trial court erred in permitting evidence of the $50,000 of punitive damages as an element of recovery in the coverage action because such a result would circumvent the well established public policy of Pennsylvania forbidding a tortfeasor to shift the burden of punitive damages to its insurer. The court stated that “in an action by an insured against his insurer for bad faith, the insured may not collect as compensatory damages the punitive damages awarded against it in the underlying lawsuit.” Id. at *12. The court based its decision on “Pennsylvania’s longstanding rule that a claim for punitive damages against a tortfeasor who is personally guilty of outrageous and wanton misconduct is excluded from insurance coverage as a matter of law,” which the court described as a “rule … based on the view that punitive damages are not intended as compensation.” Id. at *10. In this regard, the Third Circuit further held that the insurer has “no duty to consider the potential for the jury to return a verdict for punitive damages when it is negotiating a settlement of the case,” and that to otherwise do so “would be tantamount to making the insurer responsible for those damages, which … is against public policy.” Id. at *21.

Although the Third Circuit remanded for a new trial to determine whether compensatory or even nominal damages could have been awarded, without submission of evidence of the punitive damages that had been awarded in the underlying state court action, the court decisively held that punitive damages awarded in an underlying personal injury matter cannot be an element of compensatory damages in subsequent coverage actions against an insurer.