Insurers Must Pay For Potentially Covered Settlements

According to conventional wisdom, a liability insurer's duties to defend and indemnify are separate and are judged by different standards: an insurer must defend if there is a potential for coverage based on the allegations against the policyholder, but the insurer must indemnify only if the "actual facts" demonstrate that the claim against the policyholder is covered under the wording of the policy. In the unusual situation where the "actual facts" are determined by specific fact-finding by the jury in the underlying case against the policyholder, that distinction works.

Conventional Wisdom Seldom Appliesto Insurance Recovery

But, in the real world, cases settle, and they often settle without any determination of the "actual facts." So, what happens to the conventional wisdom in those situations? Courts sometimes allow insurers to examine the facts known at the time of settlement or even allow the insurers essentially to litigate the underlying case against the policyholder to develop the so-called "actual facts." Insurers are especially eager to follow that approach in situations where some, but not all, of the allegations are potentially covered. In those situations, the insurer usually agrees to defend the action under a reservation of rights, which provides a defense to the policyholder, but still allows the insurer to try to avoid paying for any of the policyholder's liability established in a judgment or settlement. Thus, the additional "fact-finding" approach allows the insurer to try to escape liability even though it has admitted the potential for coverage under its policy.

Permitting an insurance carrier to re-litigate facts in an underlying case is the wrong approach —especially when no facts have been developed in the underlying case beyond the complaint. Rather, in those situations, the insurer's duty to pay the settlement should be judged by whether the allegations potentially fall within coverage. In other words, if there is a duty to defend, there is a duty to indemnify the settlement.

The Duty To Defend Is Determined by the Potential for Coverage

In nearly every jurisdiction, a liability insurer has a duty to defend its policyholder if underlying complaint alleges facts that potentially bring suit within policy coverage. This means that, if any part of the complaint is potentially covered, the insurer must defend the entirety of the lawsuit. See e.g. Montrose Chem. Corp. v. Superior Court, 861 P.2d 1153, 1157 (Cal. 1993)...