1. By failing to provide the policyholder with a proper and effective reservation of rights letter.
2. By failing to handle the claim in good faith, even if coverage is later denied.
I agree with you. Both situations are compelling, my dear Readers. Nonetheless to protect your vulnerability we shall review only Rule #1 for today. It is considered prudent in polite society to refrain from biting off more insurance meat than one can chew in a single sitting. It could cause insurance reflux – a dangerous condition where one regurgitates arcane insurance law ad nauseum during cocktail parties, funeral services, impromptu business lunches, and grade school musicals. To avoid such a Turrettian horror, we will have only one rule for today. Rule #2 shall come later.
Let’s get into it, then, with these insurers to find out how and why they can be held liable – even if their policies do not provide coverage.
Rule No. 1: An insurer must send a “proper and effective” reservation of rights letter.
Insurance companies most often issue a reservation of rights (ROR) letter to policyholders at the outset of a claim. These are de rigueur in the industry. By doing so, the insurer is effectively denying the claim, unless and until later-developed facts show that it should be covered. Because these ROR letters often leave the policyholder high and dry during the life of the claim, courts are strict with insurers on when, why and under what circumstances such letters can rightfully be issued. And with what they must say.
The very recent case of Advantage Bldgs. & Exteriors, Inc. v. Mid-Continent Cas. Co., ___ S.W.3d ___ 2014 WL 4290814 (Mo. Ct. App. Sept. 2, 2014) (motion for rehearing or transfer denied Sept. 30, 2014) explains this rule in more detail. There, the insurer Mid-Continent issued a ROR letter to Advantage after Advantage tendered a lawsuit asking for coverage. The ROR said that Mid-Continent would “promptly” make a decision and that it would let the policyholder know if there was coverage.
Advantage, the policyholder, later wrote several letters demanding coverage. Mid-Continent ignored them. Even though Mid-Continent provided a defense, it refused to participate in mediation or to pay on the claim. This was because Mid-Continent internally had already made a decision to deny payment. It failed to inform Advantage of its conclusion. The underlying lawsuit went to trial. Advantage lost. There was a big verdict.
Ultimately Mid-Continent filed an action asking a Missouri court to deny that its policy covered the Advantage loss. The court agreed that there was no coverage. Regardless, the court ruled that Mid-Continent acted in bad faith by failing to provide a “proper and effective” ROR letter to Advantage. The ROR letter should have adequately apprised Advantage of the specific reasons why coverage is in question. The court awarded the full policy limits to Advantage as damages for Mid-Continent’s bad faith. Ouch.
The Missouri Court of Appeals upheld the ruling. It stated that:
Defending an action with knowledge of non-coverage under a policy of liability insurance without a proper and effective reservation of rights in place will preclude the insurer from later denying liability due to non-coverage. …Thus, regardless of the court’s January 2012 declaratory judgment ruling that the policy language did not explicitly cover the claims of (the underlying claimant in the lawsuit against the policyholder), because Mid-Continent failed to effect a proper reservation of rights, it was prohibited from asserting only limited coverage for the claim. Therefore, Mid-Continent was estopped to deny coverage for the claim to the extent of its policy limits. …The circuit court did not err in submitting the bad faith claim to the jury despite its declaratory judgment to the effect that the policy language did not expressly provide coverage.
Id., slip op. at 9. The Court of Appeals affirmed judgment for the full policy limits to Advantage.
Why is this case important to us? Most all states, by regulation, require an insurance company to swiftly investigate claims and to make a determination of coverage one way or the other – without waiting until a lawsuit is filed or a verdict is rendered against the policyholder. Delay harms the policyholder. To avoid violating this rule, there has been a pattern and practice in the insurance industry of sending a generic form ROR letter at the outset of every claim stating that the insurance company needs more information to accept or deny the claim – whether this is true or not -effectively putting such a decision for coverage on indefinite hold. A generic ROR is now considered to be unacceptable – at least in Missouri.
If an insurance company is going to issue a reservation or rights letter, it had better clearly and succinctly explain its specific reasons for delaying a determination of coverage. If the insurance company later determines that there is, or that there is not coverage, it must inform the policyholder as soon as possible in order to avoid any undue risk to the insured.