Significant Recovery Opportunities Where An Insured Breaches Its Reimbursement Policy Obligations For Advanced Deductible, Self-Insured Retention, Or Other Fronted Costs
July, 2008
by Dean S. Rauchwerger and Kenneth R. Wysocki
Introduction
Many insurance policies contain endorsements or other provisions wherein insureds are obligated to reimburse their insurers for: (a) deductible amounts advanced for settlements and other expense; and (b) self-insured retention amounts fronted by the insurer. These types of provisions are frequently included in policies insuring high-risk or specialty risk insureds in the third-party liability coverage context. When an insured fails to fulfill its contractual duties to reimburse its insurer, a right of recovery exists for amounts due under the policy.Discussion
The majority of jurisdictions allow insurers to recover deductible reimbursements when: 1) the policy provides for reimbursement; and 2) the insurer acted in good faith. Generally, courts interpret deductible reimbursement provisions the same way they interpret any other contract, by applying general contract law. In applying contract law to deductible reimbursement provisions, most courts uphold deductible reimbursement provisions by finding that such provisions do not contravene public policy or violate state statutes. Accordingly, when there is a legal dispute involving the recovery of deductibles, courts often grant summary judgment for the insurer and award the deductible amounts owed, along with interest and court costs. American Protection Ins. Co. v. Airborne, Inc., 476 F.Supp.2d 985 (N.D. Ill. 2007); Nationwide Mutual Ins. v. Public Service Co. of North Carolina, Inc., 435 S.E.2d 561 (N.C. App. 1993); Ins. Co. of North Carolina v. L.C. Young Painting & Decorating Co., 161 N.W.2d 24 (Mich. App. 1968).
At times, disputes arise when the insurer settles a third party's claim over the insured's objections or without the insured's consent. This usually occurs when the insured believes it should not be liable for the claim or that it can succeed in litigating the claim. However, when an insurer exercises its contractual right to settle rather than litigate, the insured may sometimes challenge the insurer's recovery of any unpaid deductibles. In such cases, courts generally enforce the policy as long as the insurer did not act in bad faith when settling.
Courts are reluctant to find bad faith even in cases where the insurer did not investigate the claim and the insurer was able to settle the claim within the limits of the deductible. Casualty Ins. v. Town & Country Pre-School Nursery, Inc., 498 N.E.2d 1177, 1178 (Ill. App. 1986). As such, courts will uphold policy language permitting insurers to settle even non-meritorious claims to avoid the possibility of greater loss exposure. See Orion Ins. Co., Ltd. v. General Electric Co., 492 N.Y.S.2d 397, 403 (N.Y. Sup. 1985). Most courts agree that where the insurer has the right under the policy to settle and acts within the monetary limits of the policy, there is no bad faith. In particular, one court noted: “We are aware of no reported case in which a court has held the covenant of good faith may be read to prohibit a party from doing that which is expressly permitted by an agreement.” New Hampshire Ins. Co. v. Rideout Roofing Co., Inc., 68 Cal.App.4th 495, 504 (Cal. App. 1998).
The pervasive view among courts dealing with these issues is that, as a matter of public policy, settlements are preferred over litigation and as long as the insurer acted within policy limits, the settlement will be treated as in good faith. As one court reasoned, “not only is it good law that the insurer may seek reimbursement for defense costs…but it also makes good sense. Without a right of reimbursement, an insurer might be tempted to refuse to defend an action in any part…With such a right, the insurer would not be so tempted, knowing that…it would be able to seek reimbursement.”
In applying these principles, courts have allowed insurers to recover unpaid deductibles in cases involving a variety of insurance policies. For commercial liability policies, courts assume that the parties have sufficiently equal bargaining power, so insurers and insureds are afforded substantial latitude in drafting and policy terms are enforced as contracted. “Liability insurance policies with deductibles are written for commercial risks” and “business persons should recognize that when they accept a liability policy with a deductible they may be called on to pay it.” American Home Assume Co., Inc. v. Hermann’s Warehouse Corp., 521 A.2d 903, 905-906 (N.J. Super. 1987). Professional malpractice insurance policies are treated similarly: “So long as coverage required by law is not omitted and policy provisions do not contravene applicable statutes, the extent of the insurer’s liability is governed by the contract entered into.” London, Anderson & Hoeft, Ltd. v. Minn. Layers Mutual Ins. Co., 530 N.W.2d 576, 577 (Minn. App. 1995); see also American Fam. Mut. Ins. v. Ryan, 330 N.W.2d 113, 115 (Minn. 1983).
Even courts addressing automobile insurance policies containing deductible reimbursement provisions have found that “an insured cannot complain that such a provision inevitably allows an insurer to commit an insured’s funds--the policy deductible--without the insured’s consent, because that is exactly the bargain that the insured struck under the policy that it bought and paid for.” American Protection Ins. Co., 476 F.Supp.2d at 990.
Similarly, courts will allow an insurer to recover any self-insured retention (SIR) amounts that the insurer advanced on the insured’s behalf. Generally, this situation arises when the insurer becomes involved in the negotiation of a settlement and then proceeds to advance the entire settlement amount, including the insured's SIR. In such a case, the insurer is entitled to recover the SIR’s full amount and courts have found that allowing the insured to avoid its SIR obligation would "yield a result at substantial variance with actuarial reality and the premium paid for the policy." Harbor Ins. Co. v. City of Ontario, 231 Cal. App. 3d 927, 935 (Cal. App. 1991).
Learning Point
In light of the many types of policies containing provisions obligating an insured to reimburse its insurer for: (a) advanced deductibles and/or expenses incurred; and (b) fronted self insured retention amounts, it is imperative that insurers appreciate the significant recovery opportunities that exist in their policy inventory when an insured breaches its deductible, SIR or other reimbursement policy obligations. Should you be interested in an in-house client educational seminar on this valuable recovery area, kindly contact CM partner Dean Rauchwerger at 312/606-7715 or drauchwerger@clausen.com.
The authors also acknowledge with thanks the contributions of William C. Dickinson, a 2008 CM Summer Associate and law school student.
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