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Insurance Coverage: 2007 Year in Review

By: Kurt W. Melchior
02/26/08

In 2007, California Courts of Appeal handed down a number of decisions on the availability and scope of insurance coverage. The changing face of the law means that policyholders hoping to maximize recovery under their insurance policies must remain vigilant. Nossaman’s coverage counsel are continually monitoring new developments and can help ensure that policyholders get the most from their insurance.

Insurer’s Bad Faith Failure to Thoroughly Investigate Before Denying Coverage

In Wilson v. 21st Century Ins. Co., 42 Cal. 4th 713 (2007), a college student sought underinsured motorist benefits from her auto insurer, supporting her claim with police and medical reports, including an orthopedist’s opinion that her medical problems were atypical for a 21-year-old and "almost certainly" resulted from the accident. The insurer denied coverage on the ground that "soft tissue injury superimposed by a preexisting degenerative disk disease" caused the student’s pain.

In affirming the Court of Appeal’s reversal of summary judgment for the insurer, the California Supreme Court agreed that the record showed the existence of triable issues of fact on whether the insurer had thoroughly investigated and fairly evaluated the claim. Noting that there was sufficient evidence for a jury to find the insurer’s decision was "prompted not by an honest mistake, bad judgment or negligence but rather by a conscious and deliberate act, which unfairly frustrates the agreed common purposes and disappoints the reasonable expectations of the other party," the Court held that "a dispute [about coverage] is not ‘legitimate’ [so as to preclude a claim of bad faith] unless it is founded on a basis that is reasonable under all the circumstances"—which this insurer’s was not.

Comment: Insurers are quick to invoke the genuine (or legitimate) dispute rule to justify delaying or denying coverage, but that rule does not relieve them from their obligation to thoroughly and fairly investigate, process, and evaluate claims.

Must Insurers Defend and Indemnify Policyholders Before the Department of the Interior’s Board of Contract Appeals?

California’s Supreme Court has granted review in Ameron Int’l Corp. v. Insurance Co. of the State of Pennsylvania, 150 Cal. App. 4th 1050 (2007). In Ameron, the First District Court of Appeal held that an administrative proceeding before DOI’s Board of Contract Appeals was a "suit" as CGL policies defined that term; the insurers were therefore obligated to defend and indemnify the policyholder. The court reasoned that the California Supreme Court’s Foster-Gardner decision did not control because the policies in Ameron, unlike those in Foster-Gardner, defined "suit" to include "a civil proceeding … includ[ing] an arbitration proceeding alleging … damages." Where the policies did not define "civil proceeding," the court found the term reasonably susceptible of more than one interpretation and construed it in the light most favorable to the insured to include a hearing before an institution that is not a court.

Comment: This case may give the high court occasion to retreat from (or to reemphasize and expand) its controversial Foster-Gardner decision denying coverage for administrative proceedings because, in the Court’s view, they are not "suits." This case also underscores that seemingly minor differences in the wording of so-called "standard form" policies can make a difference between coverage and no coverage. Policyholders should carefully review their CGL policies to determine whether their language falls within the confines of coverage-limiting decisions.

Excess Insurers Need Not Fund Settlements—Judgment Required

In Aerojet-General Corp. v. Commercial Union Ins. Co., 155 Cal. App. 4th 132 (2007), the Third District Court of Appeal held that in the absence of a court order requiring the insured to pay money to the opposing parties, excess insurers have no duty to indemnify settlements. The court called its decision "compelled" by the high court’s 2001 Powerine decision, which builds on Foster-Gardner and limits insurers’ indemnity obligation to "damages"—a policy term Powerine narrowly defined to mean "money ordered by a court." The California Supreme Court denied review, making it imperative that policyholders contemplating settlement take steps to protect their rights to coverage.

Comment: Policyholders should attempt to have all insurers on the risk agree, in writing, to the terms of any settlement before it is signed, and should carefully document efforts to obtain consent from recalcitrant insurers. If consent is not forthcoming, policyholders should consider structuring any settlement to include court approval and an order requiring payment.

Insurer That Defends and Pays Policy Limits Can Still Be Liable for Bad Faith Failure to Settle

In Archdale v. American Int’l Specialty Lines Ins. Co., 154 Cal. App. 4th 449 (2007), the Second District Court of Appeal held that while an insurer that provided a defense and paid its $500,000 policy limits in a personal injury suit against its policyholders could not be liable for breach of express policy terms, it could be liable for breach of the implied covenant of good faith and fair dealing for refusing multiple reasonable settlement offers within the policy limits and leaving the policyholders to suffer a judgment in excess of those limits. The main issue was whether the bad faith suit was time-barred. The court held that the two-year limitations period barred recovery under a tort theory, but the four-year limitations period for breach of contract actions had not yet run, because it was tolled until all appeals were resolved. The policyholders’ suit was therefore timely and the insurance company was liable for the full amount of the $1,269,000 judgment in the underlying action.

Comment: While there is no express obligation to settle a case, the implied covenant of good faith and fair dealing requires an insurer to do so if there is potential liability, a judgment will likely exceed the policy limits, and settlement can be made within those limits. An insurer that fails to give the policyholder’s interests at least as much consideration as it gives its own interests can be held liable in contract or in tort for the full amount of the excess judgment.

Health Insurer’s Cancellation of Policy Characterized as Prohibited Post-Claims Underwriting

In Hailey v. California Physicians’ Service, 158 Cal. App. 4th 452 (2007), the Fourth District Court of Appeal reversed summary judgment in favor of an insurer that rescinded a health care policy for misrepresentations. The alleged misrepresentations stemmed from a wife’s belief that the application she completed asked only for her own medical history, not for her husband’s or her son’s. When an auto accident left her husband completely disabled, the insurer authorized $457,000 in health care, but then retroactively rescinded the policy. In reversing summary judgment for the insurer and permitting the policyholder’s bad faith claim to proceed, the Court of Appeal commented that the facts of the case raised "the specter that Blue Shield’s final decision to rescind the Hailey’s plan may not have come about because of omissions in the application, but because of the substantial medical bills resulting from Steve’s automotive accident." The court held that the Knox-Keene Health Care Service Plan Act of 1975 precludes rescission unless the insurer can prove either (1) that the policyholder’s misrepresentations were willful or (2) that the insurer had made reasonable efforts, during the pre-contract underwriting process, to ensure that the subscriber’s application was accurate and complete.

Comment: While this decision faults insurers that fail to take even minimal steps to ensure the accuracy of information submitted during the underwriting process, it also underscores the need for applicants to be as accurate and complete as possible in completing applications for insurance coverage.

Excess Insurer Need Not Defend Until All Primary Coverage and SIRs Have Been Exhausted

In Padilla Construction Co. v. Transportation Ins. Co., 150 Cal. App. 4th 984 (2007), the Third District Court of Appeal reiterated the rule of horizontal exhaustion, holding that even in cases of continuing loss, an excess insurer has no duty to drop down and defend until all primary coverage is exhausted. Padilla was a construction defects case. After exhausting the defending primary insurer’s policy, the insured chose not to trigger the remaining primary policy (covering another time period on the same risk) and instead demanded that the insurer that issued the umbrella policy above the exhausted primary policy drop down and defend. The court held that the umbrella carrier had no obligation to defend until all primary coverage was exhausted. More importantly, the court held as a matter of first impression that an excess insurer has no duty to drop down and defend a policyholder with a self-insured retention until both the self-insured retention and all primary insurance are exhausted.

Comment: Policyholders should not expect their umbrella or excess carriers to provide a defense until all primary coverage on the risk and all SIRs are exhausted. But this case does not address the contention that self-insured periods (as distinguished from SIRs) must also be exhausted—a contention rejected by earlier case law.

Kurt W. Melchior is a partner at Nossaman with over 30 years' experience in complex litigation, including insurance coverage litigation. He can be reached at (415) 438-7279 or kmelchior@nossaman.com.

Deborah E. Beck is a senior associate in the firm’s Litigation practice specializing in insurance coverage, environmental and appellate matters. She can be reached at (415) 438-7254 or dbeck@nossaman.com.

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