In an October 16, 2008 Opinion, the New York Insurance Department concluded that “a D&O liability policy may not include a provision that places the duty to defend upon the insured, rather than the insurer.” See OCG Opinion No. 08-10-07. The Opinion arises from the Department’s denial of an insurer’s filing of proposed policy language on the ground that this language specifically placed the duty to defend on the insured rather than on the insurer. The Department reasoned that, although no New York case has squarely “addressed the Superintendent’s authority under the Insurance Law to require a D&O policy to place the duty to defend upon the insurer,” such authority “derives from Insurance Law [Section] 2307,” which generally provides that the Department’s Superintendent has the authority to disapprove of a proposed policy form if the Superintendent deems it to violate public policy. The Superintendent deemed placing the duty to defend on the insured to violate the public policy of “protect[ing] a potential liability policy claimant from being denied compensation under the policy due to failings of the insured.” The Department elaborated that, “if an insured were to fail to satisfy its duty to defend to the satisfaction of the insurer or obtain all of the necessary approvals and the insurer were to try to disclaim liability under the policy, that result would [violate the public policy that] establishes that the insurer be directly responsible for paying claims on behalf of the insured.” Further, the Department reasoned that placing the duty to defend on the insured would, contrary to New York regulation, limit the availability of coverage for legal defense costs, as placing the duty upon the insured “would condition defense cost coverage upon the insured taking charge of the defense.”
The insurer cannot avoid having the duty to defend placed on it by issuing indemnity-only D&O coverage that does not reimburse the insured for its defense costs. According to this Opinion, the Department “requires personal injury liability insurance coverage, including D&O insurance, to include coverage for legal defense costs associated with a covered claim.” Based upon this Opinion, it appears that an insurer writing D&O coverage, because it must cover defense costs, also must bear the duty to defend if it is to issue D&O coverage in New York.
There are at least two problems with the Opinion. The first is that it enunciates a public policy of “protect[ing] a potential liability policy claimant from being denied compensation under the policy due to failings of the insured.” If taken at face value, then this public policy may preclude an insurer from contractually placing other duties on the insured, such as the duties to timely and honestly report claims against the insured and to cooperate in the insurer’s evaluation of such claims. It is conceivable that the Department’s public policy may forgive an insured from its normal duty to cooperate in the insurer’s handling of the insured’s defense.
The second problem with this Opinion is that it attempted to distinguish the duty to defend from the right to control the defense. Many sophisticated insureds not only negotiate the specific terms and conditions of the D&O coverage they purchase, they in fact want to control the defense of covered claims. Controlling the defense would allow the insured to select counsel and to make strategic decisions in terms of directing the litigation. In response to this fact, the Department contended that “[N.Y. Comp. Codes R. & Regs. tit. 11, Part 71] does not limit the extent to which a liability policy may afford participation rights to an insured, provided that the insurer retains the duty to defend.” In fact, the Department went so far as to state that it “conceivably would approve a policy filing under which the insured has an option to exercise some degree of control over or significant participation in the defense of a claim, provided that the insurer maintains the ultimate duty to defend.” This, of course, may lead to more conflict and uncertainty than cooperation as there clearly is no line of demarcation between which entity really controls the litigation.