An insurer that defends its insured against a third party’s lawsuit, while reserving rights to deny coverage to its insured for any judgment, may face a decision point when underlying settlement discussions become ripe to resolve the case. In some state, the insurer must decide whether to stand on its coverage defenses, or whether to withdraw its reservation of rights with the understanding that it will pay for the settlement within its policy limits and waive those defenses while it gains control over the settlement negotiations. These decisions are among the greatest challenges, and are often the most time-sensitive issues, that third-party liability insurers may face when invited to participate in underlying mediations.

One of the key factors influencing whether withdrawing the reservation is prudent, is the strength of the coverage defenses being asserted. Some jurisdictions, such as Texas, are explicit that an insurer’s duty to settle extends only to the covered claims and not the non-covered claims. Given this clear law, in Texas a carrier can control the defense and settlement, even while its reservation of rights is outstanding. Other states are less explicit. They may generically permit an insurer defending under reservation to offer contributions to an underlying settlement based on the strength of its coverage position, or they may not have clear case authority on the subject at all. Uncertainties may also exist if various “duty to settle” cases in the applicable jurisdiction come out different ways based on their unique facts. One thing is certain: when the insurer withdraws its reservation, any “conflict of interest” ceases that may have been based on the insurer’s potential non-coverage of a claim it defends, and the insurer’s and insured’s interests align in protecting the policy limits (e.g., to cover the insured’s potential future losses).

It may be useful for the insurer to establish and maintain a coverage defenses “strength scale,” identifying the insurer’s likelihood of prevailing on each basis for claiming it owes no indemnity coverage. The strength of the insurer’s coverage defenses would be assessed initially when its reservation of rights letter issues, and on an ongoing basis thereafter. Periodic revisions – or at least revisiting the initial coverage position – is wise, to be revisited later, especially when the underlying matter moves into mediation or settlement discussions. That way, an insurer uses current information to assess the reserved defenses and rights that it would be giving up in exchange for its gain of control over settlement.

Preparing to assist an insured in underlying settlement negotiations is a complex process that should be informed by several assessments. Coverage counsel or the claims handler should allocate, where possible, defense counsel’s objective assessment of the overall case’s value between covered and non-covered claims. Additionally, the insurer and its coverage counsel must be familiar with the applicable jurisdiction’s rules on entry (and challenge) of a “consent judgment” against the insured with a covenant not to execute and assignment of their claims against the insurer, especially where the underlying claimant’s settlement demand exceeds the policy limit and genuinely involves potentially uncovered exposure for the insured. Analyzing the insurer’s complete claims handling history, compared to applicable case law, will also help to inform the insurer’s evaluation of extra-contractual claims that would be part of the insured’s assigned claims.

The coverage defenses “strength scale,” especially when subject to timely reassessments, can be another important tool in preparing the insurer for underlying settlement discussions.