Insurers have generally two departments: underwriting and claims. Underwriters negotiate the terms of the offer of insurance and include, in their internal analysis, how much risk the insurer wants to accept and at what premium. Likewise the businesses seeking insurance consider how much risk their business should assume against the cost of the insurance, that is, what will remain self-insured and how much premium is acceptable. Most businesses would expect that once the underwriter’s offer of insurance or binder is accepted, with an acceptable deductible or Self Insured Retention (SIR), and the premium is paid, the terms of the insurance contract would not change for the duration of the contract. That’s how it works with any other contract. Any later changes would have to be in writing and signed by both parties. However, that’s not how many insurers may view it in the event the insured actually needs to use the insurance, and a claim is presented to the claims department.
Once a claim is presented, insurers will attempt to increase the SIR by arguing that some part of the defense or some part of the settlement/judgment is uninsured, and therefore is self-insured by their policyholder, which in effect may double or triple the SIR! We call that post claims underwriting. We have actually seen an uptick in this practice where the claims adjusters are faced with lawsuits where some of the causes of action allege claims unlikely to be covered. After reluctantly agreeing to defend, the adjuster will argue that they are entitled to allocate away some part of their cost of settlement back to the insured in effect, increasing the SIR!
Thus, despite the clear terms of your policy and decades of common law, post claims underwriting is alive and well! In the distant past, the only context we would see allocation arguments is with Directors and Officers (“D&O”) claims because the early forms of these policies just insured the claims against the D’s and O’s and not the company itself, while the lawsuits these policies were meant to defend generally made claims against both. The D & O insurers in effect insisted on increasing the SIR by insisting some of the litigation costs related to defense of the “non-insured” company, so they only have to pay part of the defense or part of the settlement—say 50%. It took the courts some time to straighten this out: In Raychem Corp. v. Federal Ins Co. 853 F. Supp. 1170 (1994) the court found that as to defense costs, so long as the defense work at issue benefited insured persons, the insurer must pay 100% of those costs even if the law firm also represented the uninsured corporation. This is obviously in line with Buss v Superior Court 16 Cal. 4th35 (1997) where the California Supreme Court finally ended the same controversy with regard to commercial general liability (“CGL”) policies, establishing that where the insurers have a duty to defend they must defend immediately and completely: pay 100% of the reasonable and necessary defense costs, even if some of the claims are not potentially covered.
The big breakthrough case eliminating the insurers’ allocation arguments on settlements in California came down in Nordstrom Inc. v. Chubb & Son, Inc. 54 F3d. 1424 (1995), establishing the “Larger Settlement Rule” that the insurer bears the burden of proving what additional cost of a settlement was solely due to uninsured persons. It is surprising that the insurers are still arguing for allocation even in CGL policies. The California Supreme Court ruled some forty-five years ago that only after paying the full judgment may an insurer prove what part was actually not covered. Hogan v. Midland National Ins. Co. 3 Cal 3d 553 (1970).
There is no end to the imagination of insurance company coverage counsel—who repackage these contentions long adjudicated against the industry for another try. The Insurers revised D & O policy forms following the Nordstrom decision by adding coverage for the companies for additional premium, and including express allocation language in the policies. CGL policies almost never contain any express allocation language, which does not stop insurers defending “mixed actions”–-some claims covered, some not—from arguing at mediations that the insured should pay some portion of any settlement. These arguments stand as a warning to policyholders that they must consider the possible impact of allocation arguments in determining what policy provisions to buy, as well as engage coverage counsel in any case where the insurer disclaims any obligation to fully pay settlements. If the insurer engages coverage counsel the insured is best served by engaging his own coverage counsel to level the field.