On May 22, 2018, the American Law Institute adopted the first Restatement of the Law of Liability Insurance. A Restatement does not create law – only elected and appointed officials and judges can do that. Rather, a Restatement tries to collect and “re-state” the law in a manner that is understandable and digestible. This is particularly important for insurance law as it varies so much from state to state. The Restatement is not binding on any court, but it can be an extremely helpful resource.
The project was the culmination of years of work by many dozens, if not hundreds, of judges, lawyers, and professors. The Restatement process consists of four primary elements: (1) ascertaining the majority rule; (2) recognizing trends in the law; (3) analyzing which rule fits best with the broader body of law and therefore leads to greater coherence in the law; and (4) evaluating the relative desirability of competing rules.
Some of the most important contributions of the Restatement revolve around refining the duties of insurance companies in the defense and settlement of potentially insured claims.
Defense of potentially covered claims
The duty to defend is one of the most important concepts in liability insurance, as an insurance company typically has the right and duty to control the defense of a lawsuit if there is any potential for coverage.
The Restatement enshrines the concept of reservations of rights letters and helpfully requires that such letters be expressed in language that is “understandable by a reasonable person in the position of the insured.” When a lawsuit could be defended in a manner that would benefit the insurance company at the expense of its insured, the insurance company must provide an independent defense, meaning that the insured can select defense counsel and control the defense while the insurance company pays the reasonable defense expenses.
The Restatement also defines an insurance company’s “right to associate” in the defense, when the insurance policy provides that more limited right in lieu of a duty to defend. This issue has received little treatment in court decisions. According to the Restatement, the right to associate includes the right to request and receive information reasonably necessary for the insurance company to assess liability and a reasonable opportunity to be consulted regarding major decisions in the defense of the action.
Settlement of potentially covered claims
The duty to make reasonable settlement decisions (defined as one that would be made by a reasonable insurance company that bears the sole financial responsibility for the full amount of the potential judgment) is another key insurance company obligation that is addressed in the Restatement. Damages for breach of the duty to make a reasonable settlement decision includes any foreseeable harm, including the full amount of damages assessed against the insured, without regard to the policy limits, as well as consequential damages. No proof of bad faith is required under the Restatement rule. Indeed, the Restatement supports holding an insurance company responsible for punitive damages entered against the insured as a result of the insurance company’s unreasonable failure to settle.
The Restatement also allows the policyholder to settle over the objection of an insurance company that has reserved its rights to contest coverage if the insurance company is given a reasonable opportunity to participate and approve the settlement, but declines either to approve a reasonable settlement or to withdraw its reservation of rights.
Remedies for breach
When an insurance company breaches its duty to defend, an insured is compelled to incur defense costs and seek recovery from the insurance company. Insurance companies often challenge those defense expenses as too high, even though the insurance company left its insured in the lurch. A comment to Section 48 notes that the reasonableness of defense expenses must be “judged from the perspective of an insured forced to defend a liability action without the timely assistance of its insurer” and “the negotiated rates that liability insurers pay their regular defense counsel are unlikely to provide a useful guide to what is reasonable.” The comment further notes that defense counsel “can agree to defer collecting from the insured all or part of the fees until after the conclusion of the insurance-coverage action without undermining the insurer’s obligation to pay those fees if the insured prevails in that action.”
The Restatement notes that the “loss-of-coverage-defense remedy is particularly appropriate when an insurer refuses to defend in bad faith” – requiring the insurance company to pay any judgment or settlement entered in such a case.
Insurance company recoupment of defense and settlement expenses
One key dispute nationally between policyholders and insurance companies is whether an insurance company can recoup defense and settlement expenses if a court ultimately holds that the insurance company owes no duty to defend or indemnify. The Restatement adopts the rule that, unless the insurance policy or other agreement explicitly allows recoupment, the insurance company has no right to recoup those defense or settlement expenses from its insured.
The Restatement should be useful to judges and lawyers because it does not merely adopt a favored rule, but also explains the different approaches followed in the various states on a whole host of commonly disputed issues. Moreover, it may serve to assist policyholders seeking to enforce an insurance company’s duty to defend and settle claims, which should benefit our system of litigation and advance fundamental fairness in the oft-unequal power relationship between insured and insurer.