Facts

This case involves an insurance dispute between claimant North County OB-GYN Medical Group (NCOG) and respondent Illinois Union Insurance Company (IU). NCOG purchased from IU a "Business Management and Indemnity Policy" which contained an "Employment Practices Coverage Section." The IU policy had a $1 million limit of liability.

NCOG was sued by its former CEO for, among other things, wrongful termination. NCOG tendered the defense of this underlying lawsuit to IU for a defense. IU acknowledged a "duty to defend" NCOG, and retained its own panel counsel to satisfy that duty. Over the next two and a half years, IU paid $1 million in defense costs to its panel counsel. IU contended that its policy was "self-depleting," meaning its limits were reduced by defense costs. On this basis, after it had spent $1 million in defense costs, IU disclaimed any continuing duty to defend NCOG, leaving its insured to fund and conduct its own defense from that point forward.

CLAIMANT'S CONTENTIONS:
NCOG contended that by its own terms the IU policy was "self-depleting" in some circumstances, but not in others. Specifically, the IU policy provided that only defense costs "incurred by the insured" would reduce its policy limits. However, since IU had a "duty to defend" NCOG, and satisfied that duty by retaining and paying its own panel defense counsel, the defense costs paid by IU were not "incurred by the insured [i.e., NCOG]," but were instead "incurred by the insurer [i.e., by IU]." This is an important distinction for three reasons. First, an interpretation of the IU policy language such that defense costs "incurred by the insured" would reduce policy limits, but defense costs "incurred by the insurer" would not, is consistent with the general rule. According to the general rule, where the insured is responsible for selecting and paying for defense counsel, such costs will usually reduce limits. However, where the insurer selects and pays defense counsel, such costs are usually paid outside of limits. Second, if IU intended defense costs "incurred by the insurer" to reduce policy limits, it could have said so and, in fact, has said so in other policies. IU's failure to use this available language "implies a manifested intent not to do so." Third and finally, at a minimum, NCOG's interpretation was reasonable. Therefore, even if IU's contrary interpretation were also reasonable, it would mean only that the language was "ambiguous" and should, therefore, be interpreted in favor of coverage.

RESPONDENT'S CONTENTIONS:
IU contended that its policy provided that that its $1 million limit would be reduced by "Loss" and by "Costs, Charges and Expenses." The policy defined these terms to include defense expenses "incurred by the insured." These four words, however, should not be used to subvert the general intent of the policy which was that defense costs would reduce limits. Also, "incurred by the insured" should be interpreted to mean "incurred on behalf of" or "for the benefit of" the insured.

Result

In its award, which was then affirmed by the United States District Court, a panel of three arbitrators found unanimously that given the language of the IU policy, defense costs paid by IU to its panel defense counsel in satisfaction of its "duty to defend" were not "incurred by the insured" and, therefore, did not reduce the policy's $1 million limit of liability.

Length

one day