The U.S. Fifth Circuit Court of Appeals held defense costs incurred in an insurer’s defense under a reservation of rights erodes policy limits notwithstanding the Mississippi Supreme Court ruling in Moeller v. American Guaranty & Liability Ins. Co., 707 So.2d 1063 (Miss. 1996). Federal Ins. Co. v. Singing River Health Sys., 850 F.3d 187 (5th Cir. 2017).

Several suits were filed against the insured hospital alleging that its employees’ pension and retirement plan had been underfunded. The hospital tendered its defense to its insurer, which defended under a reservation of rights, noting that defense costs deplete the policy limits. The insurer then filed a declaratory judgment action to address certain exclusions. The insured counterclaimed alleging waiver, estoppel, civil conspiracy, breach of contract, tortious interference with contract, breach of fiduciary duty, breach of the duty of good faith and fair dealing, bad faith, interference with contract and business relations, and conversion. Both parties moved for summary judgment. The district court granted the insured’s motion, entering judgment that defense costs should not be deducted from policy limits. The district court also granted the insurer’s motion that its obligations are limited to the policy’s sub-limit for fiduciary liability coverage and denying coverage under a certain exclusion. Both parties appealed.

The Fifth Circuit addressed the insured’s argument that the Supreme Court of Mississippi’s decision in Moeller required the insurer to pay defense costs regardless of policy limits, and held that Moeller merely requires the insurer to pay for the insured’s separate counsel where a conflict exists. The Fifth Circuit next analyzed the Supreme Court of Mississippi’s decision in Southern Healthcare Services, Inc. v. Lloyd’s of London, 110 So.2d 735 (Miss. 2013) where it held Moeller does not establish an absolute right to reimbursement of all defense costs and stated “where the policy specifies that defense costs are included in the deductible, the insurer is not responsible for defense costs until the deductible has been paid.” The Fifth Circuit reversed and held that the insurer’s duty to pay defense costs is subject to the policy terms which state that defense costs erode policy limits.