Splitting Insurance Coverage and Liability Defense Files
Insurance companies have the right to defend their insureds under a “reservation of rights” so as to preserve the denial of indemnity should a claim fall beyond the scope of coverage. See, e.g., Brohawn v. Transamerica Ins. Co., 276 Md. 396 (1975). This common practice of providing a defense while reserving on the ultimate coverage decision creates a potential conflict of interest in certain circumstances. Surprisingly, there are relatively few cases discussing the challenges insurers face when dealing with this conflict of interest, including the decision of whether to separate internal coverage from liability claims files. This presents a dilemma for carriers who face potential bad faith claims and/or estoppel claims from denying coverage by insureds dissatisfied with the ultimate coverage decision.
While there are no bright line tests, lessons can be learned from courts that have considered how insurance companies discharged their obligations. In Employers Ins. Of Wausau v. Albert D. Seeno Construction Co., 945 F.2d 284 (9th Cir. 1991) the 9th Circuit held that the insurance company acted appropriately where separate counsel was retained for the liability and coverage claims, notwithstanding the fact that a single adjuster handled both files. In that case, the court relied heavily on the fact that the insured had selected independent counsel of its own choice. In contrast, in Twin City Fire Ins. Co. v. City of Madison, 309 F.3d 901 (5th Cir. 2002), the 5th Circuit held that there was a jury issue created as to estoppel and bad faith claims where counsel for the insured reported to a single adjuster who, allegedly, used privileged information to later deny coverage. That case stemmed from a subsequent declaratory judgment action in which the insurer sought reimbursement of settlement proceeds and the insured claimed, among other things, that it was not sufficiently advised of the potential conflict of interest and sharing of information by its counsel. Somewhere in between these two cases is Armstrong Cleaners, Inc. v. Erie Insurance Exchange, 364 F.Supp. 2d 797 (S.D. Ind. 2005), where the insurer erected an internal “Chinese Wall” and used separate adjusters to handle the liability and coverage claims. In that case, the insurer insisted that its insured use counsel selected by the insurer. Ultimately, that court concluded the carrier’s internal segregation of files only applied to “front line adjusters” and did not extend up to the supervisor level, thus there was a sufficient conflict such that independent counsel was required, but not enough to establish bad faith.
To summarize, there is no bright line test establishing when a sufficient conflict of interest exists such that the carrier must segregate its internal coverage and liability claims files. Complicating matters is the fact that some insurance companies and/or third-party administrators may not have the resources to internally split claim files from liability files. The issue of when independent counsel is required is equally convoluted and yet further complicated by the applicable ethical rules of professional conduct, which do not apply to insurance adjusters. For these reasons, insurers and insureds faced with these situations are well-advised to seek counsel early to evaluate the best course of action. For more information on when to split insurance coverage and liability defense files, or to discuss these issues as they may apply to your case, contact the attorneys at Walker, Murphy & Nelson, LLP today.
Disclaimer: This article is for general informational purposes only. Nothing contained herein constitutes legal advice, nor does it create an attorney-client relationship. All persons reviewing this should consult counsel for advice regarding any specific legal questions and any unauthorized use of this information is expressly prohibited.