New decision clarifies insurers' duty to provide a defense

The duty of an insurer to provide a defense of potentially covered claims is a major reason for insureds to purchase commercial general liability insurance. And, in many instances, despite insurer efforts to argue for a contrary result, the duty to defend, or for an insurer to participate in an insured's defense is triggered at the outset of litigation, not at some later point after a policy's "self-insured retention" (SIR) has exhausted. The 4th District Court of Appeal recently reconfirmed this important principal in American Safety Indemnity Co. v. Admiral Insurance Co., 2013 DJDAR 13159 (Sept. 27, 2013). It held that an insured has a reasonable expectation of a defense even when the policy states its limits of liability for damages are in excess of the insured's payment of an SIR.

In that case, American Safety sued Admiral for equitable subrogation of defense costs American Safety paid on behalf of Admiral's named insureds in underlying subsidence litigation.

In the underlying litigation a developer and grading contractor, among others, were sued by homeowners when slope grading related to the construction of new homes resulted in a series of landslides that damaged already existing adjacent homes. The grading contractor was insured by American Safety. The developer was insured by Admiral, but was also an additional insured under the American Safety policy. The developer tendered its defense to American Safety, who denied the claim. The developer then sued American Safety for bad faith failure to provide its additional insured a defense. The developer's bad faith lawsuit was ultimately settled with American Safety agreeing to pay the developer's defense costs in the underlying litigation.

American Safety proceeded to pay the defense costs of not only the developer, but two of the developer's related entities, which had also been sued in the underlying litigation. All three were represented by the same law firm, which refused to provide segregated billing for the three entities. While the developer was an additional insured on the American Safety policy, the developer entities were not. However, the developer entities were named insureds on the Admiral policy. Therefore, once the underlying litigation settled, American Safety sued Admiral for reimbursement of the defense costs it paid for the developer entities.

As its main defense to paying for the developer entities' defense costs, Admiral stated that because the SIR in its policy had not yet been exhausted, it in essence was an excess insurer that owed no defense duties to the developer entities. And, if Admiral owed no duties to its own insureds, then Admiral argued that American Safety was not entitled to subrogation for those duties. The trial court and Court of Appeal disagreed.

The Court of Appeal emphasized that it is a "well-established principle that any limitation on the coverage provided by a liability insurance policy must be express and consistent with the reasonable expectations of the insured." It noted that the Admiral policy was written on a "Commercial General Liability" form, the face identified it as providing primary coverage, and it became "excess only when other coverage is available to its insureds by way of other insurance acquired by the insureds or when the insureds are named as additional insured on another party's policy."

It explained the important "distinct roles" played by primary and excess insurance: "a primary insurer typically charges a greater premium than an excess insurer, because the primary insurer will normally bear the cost of providing the insured with a defense. When settlement or judgment exceeds the limits of the primary insurer's policy limits, the excess insurer will be required to contribute to the settlement or judgment but, typically, because a judgment or settlement ends the lawsuit, the excess carrier will not pay any of the insured's defense costs."

Using these insurance principles and the express language of the Admiral primary policy, the court held that Admiral could not be considered as excess to the SIR. According to the court, whereas an excess insurer has no defense duty until exhaustion of the primary policy unless policy language states otherwise, "in the case of a primary policy with an SIR provision, the presumption with respect to defense costs, which operates in favor of an excess carrier, has no application" because, under California law, self insurance is not insurance.

The court quoted extensively from Legacy Vulcan Corp. v. Superior Court, 185 Cal. App. 4th 677 (2010), for support: "One of the reasons for this rule is that the defense obligation falls on the primary insurer, whose greater premium reflects that risk. It is unnecessary to impose an immediate duty to defend on the excess carrier to afford the insured that to which it is entitled, namely, the full protection of a defense on its behalf. Another reason for the rule is that, absent policy language to the contrary, the insured could have no reasonable expectation that an excess insurer would provide a defense before primary insurance is exhausted.

"These reasons, however, do not justify extending the rule that an excess insurer has no duty to defend unless the underlying primary insurance is exhausted to insurers who provide primary umbrella coverage with a self-insured retention, absent clear policy language so providing. So-called self-insurance is no insurance and affords the insured no protection at all. To require the exhaustion of a self-insured retention before an insurer will have a duty to defend would not ensure that the defense obligation rests on the insurer receiving premiums for that risk, but instead would result in no insurer providing a defense prior to exhaustion. Moreover, in the absence of clear policy language so providing, to require the exhaustion of a self-insured retention before an insurer will have a duty to defend would be contrary to the reasonable expectations of the insured to be provided an immediate defense in connection with its primary coverage." (Internal quotations and citations omitted).

The court concluded that because Admiral's policy did not "expressly and unambiguously make its duty to defend subject to the SIR," it owed defense duties.

Accordingly, when an insurer denies a defense on the grounds that the policy's SIR has not been met, the insured or additional insured should review the policy's language carefully to ensure that it expressly and unambiguously provides the insurer with a right to do so by for example stating that the SIR applies to defense costs, not just "damages." In the absence of this express language, insureds should argue that the insurer owes a defense duty from the outset of the underlying litigation and may not delay its participation in the defense until after an "SIR" has been satisfied.