The relationship between a business and its insurance company is purely contractual. The insurance policy is the contract between the two parties and lays out the obligations of each side. The government regulates the privileges and duties of each party and the consequences of any breaches. There are a number of laws and state statutes that deal with insurance policies.
Because insurance is a contract, you should always read your insurance policy before purchasing insurance. The language of the policy will impact your obligations. The language of an insurance contract means that a lot of insurance cases will be tried on a case by case basis and place a heavy emphasis on policy language.
Luckily, a lot of insurance companies use a standard form for writing liability insurance. This is especially the case for CGL or commercial general liability. The main purpose of commercial general liability insurance is to protect the insured against third-party liability claims. If a claim is successful and covered by the insurance policy, the insurance company will pay the damages as per the policy. Many insurance policies will have strict obligations for this benefit, primarily paying premiums on time. Most CGL insurance will also require the insured to allow the insurance company to inspect the business premises and conduct routine audits.
What Are the Insurance Company’s
Obligations?
For a standard CGL policy, the insurance company has the following obligations:
- The insurance company will pay any damages the insured is legally obligated to pay because of property damage or bodily injury.
- The insurance company has a duty to defend the insured in a lawsuit, thus giving them the opportunity to control the lawsuit.
- The insurance company may investigate and settle any claims as it sees fit.
However, the insurance company is not obligated to pay settlements or damages above the limit of their policy.
So, in summary, the insurance company has four privileges/duties: to investigate, to defend, to settle, and to indemnify. We will discuss all of these further.
The Insurance Company’s Duty to Defend
The defense provisions in CGL insurance policies have often been referred to as “litigation insurance.” This is because the insured will not have to pay for legal defense or supervise their defense lawyer.
The insurance company also has an obligation to pay the following items:
- Costs that are taxed against the insured
- Prejudgment interest on the portion of the damages the insurance company pays
- Post-judgement interest on the whole amount of the damages until the insurance company pays their portion.
- Appeal bond premiums
- Requested expenses of the insured
Read more about this in the Supplemental Payments clause. It states that the costs of these items and of the defense will not reduce the liability policy limits.
The Comparison Test
The duty to defend the insured is based on the facts that are alleged in a lawsuit or complaint. To determine the duty to defend, an insurance company must use the comparison test to see what losses may occur based on the allegations. Then the insurance company must see if these losses are covered in the insurance policy terms.
If the allegations are within the scope of the insurance policy (or could reasonably be considered so), then the insurance company must fulfil their duty to defend. The underlying complaint must only be possibly within the scope of the insurance policy. Therefore, if there is any doubt, the insurance company would have to defend the insured and perhaps issue a ROR letter.
The insurance company usually cannot use information from sources other than the complaint to not fulfil its duty to defend. Even if the insured tells the insurance company that information themselves. Therefore, even if the claim is baseless, the insurance company must defend the lawsuit.
The Obligation of Reasonable Performance
When the insurance company fulfils their duty to defend, they have a duty of reasonable performance. This has been made clear in Supreme Judicial Court rulings.
Termination of the Defense
If the insurance company believes the plaintiff and insured are conspiring to defraud the insurance company, then the insurance company has a right to disclaim defense duty – even if the accident did actually happen. The insurance company will then file declaratory action against the insured and the plaintiff. Until the insurance company can prove that the plaintiff’s case is not covered by the insurance policy, then the insurer must perform its duty to defend.
The duty to defend is based on the allegations of the lawsuit, not the facts of the case. An insurance company must perform their duty to defend if the allegations mostly fall in the scope of the insurance policy.
The Duty to Defend In The Case of a Mixed Claim
If the allegations of the claim may possibly be covered by the insurance policy, then the insurance company has a duty to defend. At times, there may be multiple claims made in the lawsuit, and some may be covered by the insurance company, and others may not. If this is the case, the insurance company has a duty to defend the whole lawsuit if they have that duty for any of the lawsuit’s claims.
Control of Defense
It is in the insurance company’s best interests to defend the claim as they will often be the ones paying the damages. The duty to defend means the insurance company can pick the legal team and control their actions. Most lawsuits will have the insurance company and the insured’s goals align. However. If there is a conflict of interest, it is not appropriate for the insurance company to retain control of defense.
For example, most liability insurance policies cover accidental injuries. If the lawsuit claims that the injury was due to negligence or intentional acts by the insured, then there will be a conflict of interest. The insured’s best interest would be for the claim to be dismissed or disproved entirely or for it to be an accident. However, the best interest of the insurance company would be to prove negligence or intentional acts, so the lawsuit is not covered by the insurance policy. Because of this, the insured should seek independent counsel rather than giving the insurance company control of the defense. In these cases, the insured can pick their own defense and bill the insurance policy for reasonable legal costs.
Defense Expenses and Policy Limits
The costs of the defense are not counted towards the policy liability limits. However, is the insurance company allowed to stop defending the insured if the defense becomes too costly? No. The obligation to defend the insured will stand, regardless of whether the insurance company has reached the liability limit. Also, if there are reasonable grounds to make an appeal, the insurance company has an obligation to do so.
Consequences If The Insurance Company Does Not Fulfil Their Duty to Defend
If the insurance company does not fulfil their duty to defend, the insured can file a claim for a breach of contract. They can recover damages that arise from the breach of contract, including the sum that they incur because they had to hire their own defense.
Effect of a Breach of Duty to Defend on the Duty to Indemnify
If the insurance company refuses to defend the insured and it turns out they had a duty to defend, then they cannot raise policy limitations or amend exclusions to avoid indemnity obligations.
Does the Insurance Company Have a Duty to Indemnify?
In a CGL policy, the prime duties of the insurance company are the duty to defend and the duty to indemnify. The duty to indemnify is basically a duty to ensure that the insured is never out of pocket, especially in terms of damages. Instead, the insurance company must pay on behalf of the insured.
The duty to indemnify is based on facts, not the allegations of the case. So while the insurance company has a duty to defend if the allegations fall within the scope of the insurance policy, if the facts that come to light during the trial show that it is outside the scope of the insurance policy, then the insurance company does not have a duty to indemnify. The insurance company will only have to pay damages based on the facts that have been proved by the plaintiff.
This can be difficult in practice, especially if the case settles because the plaintiff does not spend time proving things.
Limits of Liability, Interest, and Costs
The full scope of the insurance company’s indemnity obligation can be quite complex to work out. It is based on the facts that the plaintiff proves in the lawsuit and the size of the insurance policy’s liability limits. These limits may be laid out in different ways, and many CGL policies will lay out liability limits for different scenarios.
If your insurance policy has a per-occurrence limit, this will set a maximum for the amount the insurance company will pay per event. This means if multiple people were injured in one accident, the liability limit is for one accident, not per person injured. Some policies may have different per occurrence limits depending on the type of claim.
Another common liability limit is an aggregate limit, which states the maximum an insurance company will pay per term. Usually, the term is 12 months. This means if you have multiple accidents, once you hit the aggregate limit, the insurance company will no longer pay damages.
The Insurance Company’s Right/Duty to Investigate and Settle
The insurance company must defend any lawsuits that fall within the scope of their policy and indemnify the insured for damages. But also, the insurance company can make investigations as they wish and also negotiate and settle any claims as they see fit. However, the insurer must also take into account the insured’s interests.
Therefore, when the insurance company exercises its right to investigate and settle claims, there is an implied covenant of fair dealing and good faith. Breach of one of these duties does not always mean there is a breach of the other. Generally, it is accepted that the insurance company would want to investigate a claim before deciding how to proceed.
What Are the Obligations of the Insured?
An insurance contract, when you boil it down to simplest terms, is an exchange of premiums by the insured to transfer the risk of loss to the insurance company. Therefore, one of the key obligations of the insured is to pay their premiums in full and on time. However, claims handling and underwriting are key obligations too.
During the insurance underwriting process, the applicant must answer questions fully and truthfully. This helps the underwriter to make their decision about premiums and whether they will issue a policy.
When handling claims, the insured has a duty to ensure the insurance company is in the best position to perform its obligations. To do this, the insured must:
- Notify the insurance company of anything that may result in a claim
- Advise the insurance company when they receive a claim
- Cooperate with the insurance company’s investigation and their defense.
The insured must also help the insurance company contain or spread the loss to keep it as low as possible.
The Duty to Be Truthful
Both the insurance company and the insured must act in good faith, and a large part of that is telling the truth.
During the application process, the burden of disclosure falls largely on the insurance applicant. This is because they are aware of any risks their business may face. If you are untruthful or fail to disclose information that may affect your policy or future claims, then you risk the insurance company avoiding coverage due to misrepresentation. The insurance policy wants to avoid paying 5-7 figures in damages and will actively look for ways to get out of that duty. Therefore, you need to make sure you do not give them any room to use misrepresentation to wiggle out of the deal.
Many underwriters will ask ambiguous questions to skew the process in favor of the insurance company. The best process is to ensure you tell the insurance company all information that can reasonably be considered pertinent to the type of insurance you are purchasing.
The Insured’s Obligation to Cooperate With the Insurance Company
The CGL policy will state that the insured has an obligation to cooperate with the insurance policy. This includes every step of the process: defense, investigation, settlement, indemnity, or right of contribution of third parties. The insured must also not do anything to restrict the subrogation rights of the insurance company.
Where cooperation issues may arise is immediately after the insured notifies the insurance company of the claim. The insurance company will often ask questions about the accident and ask for documents so they can begin to build their case.
Learn more about Insurance Defense – What to do when you receive a reservation of rights letter for your insurance company.