A liability insurance company has the right to take over the defense of a policyholder and to control all settlement discussions.  What happens if the carrier fails to pursue settlement negotiations with sufficient zeal, knowing full well that it was leaving the insured exposed to liability above policy limits?  You may be at risk in California if your insurer does this to you.

This is how the California State Court of Appeal described the issue in Reid v. Mercury Ins. Co.: “This case involves an insurer’s duty to its insured to settle a third party claim within policy limits, when liability is clear and there is a substantial likelihood of a recovery in excess of policy limits.”  (Get a copy of the opinion here.)

A good place to start, before discussing the specific facts of the case, is to look at the rights that the standard liability insurance contract gives to the carrier to control defense and settlement of a case against its policyholder.  The typical insuring agreement says: “We will pay those sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage’ to which this insurance applies.  We will have the right and duty to defend the insured in any ‘suit’  seeking those damages.” 

What this means is that the carrier takes complete control of the defense of the case against the insured.  It usually hires “panel” counsel to represent the insured; that is, a lawyer from a big list of lawyers who have been approved to represent insureds in cases the carrier defends.  There are a number of factors that go into getting onto the list of panel counsel and these factors will vary from carrier to carrier.  Such lawyers are essentially always willing to work at an hourly rate to be paid by the carrier that is lower — sometimes very dramatically lower — than the prevailing rate for attorneys of like experience. 

With the right to control the defense comes the right to settle the claim against the policyholder.  The standard policy says: “We may, at our discretion, investigate any ‘occurrence’ and settle any claim or ‘suit’ that may result.”  The carrier’s settlement authority extends so far that it can refuse to pay any settlement that the insured negotiates for itself (or for him or herself).  The policy says this about that: “Neither you nor any involved insured may make any settlement without our consent.”

Thus, with a few exceptions not relevant to this discussion, and in a typical case, the carrier has absolute and complete control over both the defense of the insured and all settlement negotiations with the underlying claimant.  As the Reid case demonstrates, this control gives the carrier very nearly absolute and unfettered power, by its actions or inactions, to deny a victim compensation for bodily injury and to ruin the insured financially for life.  The facts and the outcome of that case are not pretty.

Reid involved a horrific car accident in which the insured, whose name was Zhi Yu Huang, ran a red light and struck another vehicle.  The collision put Shirley Reid, the driver of the car that was struck, into the intensive care unit for months.  The accident also injured Ms. Reid’s passenger as well two other people who were in a third car.  Ms. Huang had a liability insurance policy that provided $100,000 of bodily injury coverage.  The record in the case showed that everyone involved, including especially the carrier, Mercury Insurance, knew very soon after the accident that Ms. Huang’s exposure far exceeded the $100,000 limits.

Nevertheless, what followed was months upon months of what Ms. Reid’s son described as getting “jerked around” by Mercury.  Successive insurance adjusters claimed to need more and more information.  They claimed to need to take a statement from the victim, even though they knew at the time that Ms. Reid was on a ventilator in the intensive care unit and might not survive.  The carrier refused — until Ms. Reid’s son, who was acting as her representative, hired an attorney — to reveal the amount of the policy limits.  In addition to the $100,000 limits in the Mercury policy, Ms. Reid had access to $250,000 of “underinsured” coverage — insurance that, as the name implies, covers a person when the tortfeasor (Ms. Huang, in this case) does not have adequate insurance to cover the injury or damage.  To trigger the underinsured coverage, however, Ms. Reid had to obtain a settlement for the $100,000 limits in the Mercury policy.

Throughout the time Ms. Reid’s lawyer was in discussions with the Mercury adjuster, the carrier never offered its policy limits in settlement.  Instead, the adjuster sent clear signals that it was “not yet” prepared to settle at all.  For these reasons, Ms. Reid’s lawyer never made a demand for the policy limits.  As he described it: “They needed to take a statement from my client and my client was in the hospital with a tube in her throat. It wasn’t at that point in time clear that she was going to live. This was $100,000 and [the carrier] elected, rather than to offer the policy, to request a statement from her. I viewed that as a refusal [to offer up the policy].”

Mercury’s internal documents clearly showed that, almost immediately after the accident, the insurer knew that there were no defenses to Ms. Huang’s liability and that the policy limits were not going to be nearly sufficient to cover Ms. Reid’s injuries.  It even informed Ms. Huang that she should hire her own lawyer, at her expense, to protect herself against claims in excess of her policy limits.  It placed a reserve (an estimate of what it will cost the carrier to resolve the matter) of $100,000 on the case.

Eventually, Ms. Reid sued Ms. Huang.  Finally, after suit was filed and very nearly a year after the accident, Mercury offered the policy limits, which Ms. Reid, at that point, rejected.  Mr. Reid, the son, later testified that he would have accepted the $100,000 policy limits had they been offered early in the discussions, so that he could have accessed the $250,000 underinsured coverage.

After two years of litigation and a bench trial (a trial by a judge rather than a jury), the court entered a verdict against Ms. Huang for $5.9 million.  The verdict drove Ms. Huang into bankruptcy and Ms. Reid acquired from the bankruptcy trustee Ms. Huang’s claim against Mercury.  Ms. Reid then sued Mercury for bad faith failure to settle.

Another fact is worth mentioning about the carrier’s obligations to an insured.  California, like many other states, has adopted a version of the Uniform Unfair Claims Settlement Practices Act.  It provides, among other things, that a carrier engages in unfair settlement practices by “[n]ot attempting in good faith to effectuate prompt, fair, and equitable settlements of claims in which liability has become reasonably clear.”

The trial court entered summary judgment in favor of Mercury.  It found no California authority “standing for the proposition that there is a duty to settle when there is a claim that is vastly in excess of the policy limits regardless of whether a settlement demand has been made.”  Ms. Reid appealed.

Remarkably, the Court of Appeal affirmed.  As a prerequisite to finding a bad faith failure to settle, according to the Court, “there must be, at a minimum, some evidence either that the injured party has communicated to the insurer an interest in settlement, or some other circumstance demonstrating the insurer knew that settlement within policy limits could feasibly be negotiated. In the absence of such evidence, or evidence the insurer by its conduct has actively foreclosed the possibility of settlement, there is no ‘opportunity to settle’ that an insurer may be taxed with ignoring.”  Yet, there was in fact plenty of California authority that would have supported the opposite outcome in this case — an outcome that was devastating for everyone involved except for the carrier.

For example, there is a 1958 California Supreme Court case in which the Court held: “When there is a great risk of a recovery beyond the policy limits so that the most reasonable manner of disposing of the claim is a settlement which can be made within those limits, a consideration in good faith of the insured’s interest requires the insurer to settle the claim.”  (That case is Comunale v. Traders & General Ins. Co.)  Two decades later, the California Supreme Court reaffirmed this duty when it observed: “The implied covenant of good faith and fair dealing imposes a duty on the insurer to settle a claim against its insured within policy limits whenever there is a substantial likelihood of a recovery in excess of those limits.”  (Johansen v. California State Auto. Assn. Inter-Ins. Bureau).  These rules recognize, as the Reid Court did not, the truly awesome power an insurance company has either to save or to ruin the financial lives of both the insured and the injured party.

It is worthwhile to think of the responsibility that comes with the power to bankrupt an insured in this way: If the carrier’s liability to Ms. Reid had not been limited to $100,000 but had, instead, been limited only to the amount that a judge or jury might award to Ms. Reid, would it have attempted sooner, more eagerly, and more aggressively to settle the Reid claim for $100,000?  Can there really be any doubt whatsoever about the answer to that question?  The undisputed facts in the record of this case make it nearly certain that Mercury would have acted very differently toward Ms. Reid — not to mention Ms. Huang — had its own $5.9 million been at risk.

First, the Court of Appeal noted that “the insured’s liability was clear almost immediately after the collision. The insurer’s claims manager had decided, within a little over six weeks, that while the insurer needed medical records, the insurer must tender the policy limits to the third party claimant ‘as soon as we have enough [information] available to do so.’”  The claimant was in critical condition in the intensive care unit and on life-support.  How much more information would have been “enough” to establish that her claim was worth a lot more than $100,000?

Second, internal company documents showed that the adjuster on the claim “recommended defendant accept 100 percent liability” less than one month after the accident.  Third, and at about the same time, the Mercury adjuster wrote to Ms. Huang to inform her that she might be exposed to liability beyond the policy limits, but promised that he would “continue our attempts to conclude this matter within your policy limits and will keep you informed as to the status of settlement offers, demands, and negotiations.”  Fourth, less than six weeks after the accident, the claims manager at Mercury made a note in the file that the carrier would have to “tender policy limits” to settle the claim and he set a reserve on the file of $100,000. 

Nevertheless, the carrier continued to insist that it needed “more information,” including a “statement” from an accident victim who was in no condition to provide one.  It would be another ten full months before the carrier actually did what it knew all along it would have to do to protect Ms. Huang from financial disaster: tender its policy limits.  At that point, Ms. Reid’s attorney must have known that Mercury’s behavior exposed the carrier to a bad-faith claim, which likely explains why the Reids rejected an offer that they would have accepted had it been made earlier.

In spite of all these unflattering facts, both the trial court and the Court of Appeal took this case away from the finder of fact and ruled in the carrier’s favor as a matter of law.  The courts concluded that no reasonable fact finder could possibly have looked at this evidence and found that the carrier had acted in bad faith in handling the settlement negotiations.

Voltaire said, “With great power comes great responsibility.”  It is hard to see how the courts that decided the Reid case imposed a duty of responsibility on the carrier that was commensurate with the absolute power the carrier wielded.