Your Insurance Company's Duty To Settle

This article was originally published in the Policyholder Advisor, Volume 25, Issue 1 (January/February 2016)

A policyholder purchases liability insurance coverage to protect itself in the event it gets sued. Assuming a claim against the policyholder triggers its liability insurance policy, the insurance company will have a duty to defend the policyholder in the litigation against it and pay for a judgment against the policyholder. At some point in the litigation, the policyholder's liability may become clear. The insurance company, however, may prefer to roll the dice and proceed to trial. The policyholder, on the other hand, may want the insurance company to pay to settle the dispute. While the insurance company's liability is generally capped at the policy's limit of liability, the policyholder could end up liable for amounts in excess of policy limits.

To protect the policyholder in situations like these, courts have recognized a duty to settle on the part of the insurance company. When the policyholder's liability is clear and a judgment in excess of policy limits is likely, an insurance company has a duty to initiate settlement negotiations. An insurance company must accept a settlement offer that is reasonable and within policy limits when a substantial likelihood exists that a verdict will exceed policy limits. This duty applies to primary as well as excess insurance companies.

The insurance company's failure to settle under such circumstances may constitute a breach of the insurance company's duty of good faith, a breach of the insurance company's fiduciary duty, a breach of the implied covenant of good faith and fair dealing, or give rise to a negligence claim. In some jurisdictions, the policyholder — and in limited instances, a third-party claimant - maintains a statutory right of action for an insurance company's failure to settle when liability has become reasonably clear. In fact, the Model Unfair Claims Practices Act — adopted by most states — provides that "not attempting in good faith to effectuate prompt, fair and equitable settlement of claims submitted in which liability has become reasonably clear" constitutes an "unfair claims practice."

The standards courts apply to determine whether the insurance company has breached its duty to settle vary. While in some jurisdictions the policyholder must show that the insurance company acted in bad faith, in other jurisdictions, mere negligence on the insurance company's part...